The debt to income (DTI) ratio is used by lenders to measure the financial risk of a person that is requesting a loan.
Lending money is a difficult profession. As a lender, you receive constant requests and applications from people that need money. Each of them has their special financial conditions, and as the lender, you need to figure out which of them is able to pay back the interest rates of the loan they are requesting.
Borrowers don’t use their instincts to do that. They use our credit scores, they run credit checks, they see your credit history and current debts and also they measure the DTI before approving your request.
Now, one of the most important factors to be eligible for a loan is the debt to income ratio. In this article, you will be able to know what is it and how to calculate it yourself so you can know if you qualify for large loans such as mortgages or car loans.
What is the debt to income ratio?
The debt to income (DTI) ratio is the metric lenders use to figure out if you can pay off the money you are requesting when you are applying for a loan. This is a procedure lenders do even for the minimum amount of money they are borrowing so they can know how risky their investment is.
It doesn’t matter if it’s for a mortgage, credit card, personal loan, auto loan, etc.
The debt-to-income ratio is based on two principles:
- The amount of money you earn.
- The amount of money you spend on debt.
So, the higher the debts, the worse would be the result of the DTI, which may give you a negative answer when you are requesting a loan.
You see, lenders often look for applicants with low DTI, because this means that their income is higher than the debts they have. And this people usually tend to maintain a high credit score and pay of their debts on time.
It is not an absolute principle, but it’s a number that helps borrowers when it comes to securing their investments. If a person with a high DTI gets a loan, it’s most likely to have high interest rates when time of repayment comes.
How to calculate Debt to Income Ratio?
In order to calculate your DTI you need to have two things into account as we mentioned before:
- Your total monthly income or gross income
This will include all the ways you use to generate money, such as earned income, passive income, social benefits, etc.
All of this is measured before taxes or any other deductions.
- Your total monthly debt payments.
It will include all your debts and obligations such as mortgage, previous loans, auto loans, credit card payments, child support, etc.
Once you have those numbers, you must divide your debts by the total gross income. This result will give you a small number, which must be multiplied by 100 so you can have your DTI expressed in percentage.
For example:
Let’s say that you have $1,000 worth of previous loans and credit card payments. You also have $100 of child support. These would give a total of $1,100.
Now, your total gross income is $4,500 a month.
Then, to calculate your debt to income ratio you must do this operation:
$1,100 / $4,500 = 0,2444
0,24 * 100 = 24,44%
As you can see, in this example, the DTI is 24,44%, which is an acceptable percentage for a lender
What is a good debt to income ratio?
As you can see above, the DTI can be easily determined with simple mathematics. This way you will be able to start to guess the probabilities you may have to get a loan application approved.
Now, you need to know that lenders do take into account the DTI percentage. And in order to have better chances to get your loan approved you must have a ratio below 43%.
Why is that?
Well, remember that this metric shows how good your income covers your debts. So, if you have a high DTI means that you may struggle to pay another loan, whether as a low DTI represents that you don’t have any problem paying your current obligations and you have extra money to get another one.
That’s what a lender sees.
However, as we said before, this is not an absolute principle. Therefore, lenders may be able to approve you a loan even if you have a high percentage because they also analyze the other factors mentioned before.
Now, you can decrease your DTI before submitting an application for a loan if you are able to:
- Find another job so you can increase your total gross income.
- Reduce your current debts.
You can find a part-time job or start a side hustle so you can make more money or pay off your credit cards at once. If you can find ways to reduce the weight that your debts have over your income, it will help your DTI.
But, remember that having a 0% ratio is also bad because this could imply that you don’t have any debt and that you are new when it comes to getting loans. It’s better to be in the middle.
If you don’t know what your debt to income ratio is, and you still have doubts about this, you can contact us and fill the fast online application so you can know which of our financial services fits for you in Oxford Funding.
