Are you entering the housing market soon? If so, then it’s important to understand your debt to income ratio. This is a metric used by financial institutions while examining a potential borrower. Depending on yours, obtaining a loan may be difficult. Here’s what you should know about debt to income ratios.
What Is a Debt to Income Ratio?
First, we have to consider what it actually is. In summary, DTI measures how much income you have relative to debt. The higher your gross monthly income, the lower your DTI, usually. However, if you take out more debt, it’ll decrease your DTI.
As a person borrows more, their DTI decreases in proportion. Whenever applying for a mortgage, banks use your DTI to see whether you qualify. If yours is relatively low, it’s easier for the bank to justify loaning money to you.
When someone’s DTI is too high, most banks won’t look at them. Instead, they’ll push them out of the pile and move on to someone else. Improving your DTI could make it much easier to find a bank willing to give you a mortgage.
How to Calculate DTI?
So, now we understand what your DTI measures. It’s time to figure out how to calculate it whenever applying for a loan. By doing this ahead of time, you’ll know how easy finding loans will be.
To get started, look at how much you’ve earned in the last month. When doing this, don’t include any taxes taken out of your pay. Use the gross pay they’ve given you while calculating everything.
Next, look at how much you’re spending on debt each month. While doing this, only consider the minimum payments due on each account. If you’ve overpaid on any of them, don’t use that figure.
Once you’ve tallied everything up, it’s time to do a little division. Divide your monthly debt obligations into your gross take-home pay. After dividing everything, you should have a ratio as the product. This is your DTI.
Why Does DTI Matter?
Once you’ve done the math, you’re probably wondering why it all matters. Dividing your income by your obligations is just the math, though. Banks use your DTI as a way to judge your creditworthiness. If you’ve let your DTI get too high, they’ll second guess any applications.
Banks won’t lend to you most of the time unless your DTI is below 43%. Anything above that would put too much risk on them to be worthwhile. So, if yours is above that, focus on lowering it first.
Also, better DTI ratios tend to get lower interest rates. So, improving yours could make a loan more affordable since its rate might be lower. When applying for loans, pay attention to the APR on each. The one with the lowest will be the most affordable one of them all.
A DTA ratio of no more than 41% is what is recommended for the VA home loan requirements. But the maximum DTI ratio for a VA loan might be higher if you have good credit, make a large downpayment, or have high residual income.
If you’ve been denied because of excessive DTI, lowering it is your only option. This is a relatively simple process, thankfully. Just pay extra toward your debts for a while. After they’ve been paid, your DTI will drop.
Paying all your accounts off would lower it all the way to 0%. However, you shouldn’t let yours drop this low. Otherwise, your credit score will most likely drop.
Closing accounts tend to lower your score. So, don’t pay close anything until you’ve taken out a loan. If they’re closed first, your score won’t be as good, meaning it’ll cost more. Since your score stays higher by keeping them open, don’t close them.
What Everyone Should Know About DTI
Your debt to income ratio has a massive impact on how easy it is to qualify for loans. When it’s too high, getting a loan is pretty much impossible. Lowering it is simple. Just pay down some of your debts, and it’ll drop in proportion. Continue paying down your accounts until your DTI is where you want it.