Why Your Debt to Income Ratio Matters and How to Determine It
Your credit score matters (especially if it’s low), but it’s not the only metric you should be concerned about when it comes to your money. If you are paying off a debt, for example, you need to be aware of the so-called debt-to-income ratio . This not only affects your ability to receive loans; it’s also just a good general indicator of your financial health.
What is your debt to income ratio (DTI)?
Generally speaking, the debt-to-income ratio looks something like this: the ratio of debt that you divided by your gross monthly income. While your credit report and score do not provide any details about your income in relation to your debt burden, this is exactly what your DTI is about.
“DTI is a more holistic way to see if you are living within your means because it gives you a true view of your monthly debt obligations versus your monthly income,” says Erin Lowry, author of Broke Millennial. “A credit score is certainly part of your financial profile, but not the complete picture. For example, you may be saddled with debt and still have a good credit rating. ”
If you have a high DTI, lenders may not lend you money or credit, or they may offer you lower interest rates, even if your credit rating is in good shape. It doesn’t really matter if you don’t shop for a loan or credit card, I suppose, but you still want to avoid a high DTI, if only because a higher ratio means it will be more difficult for you to pay off your debt. …
How to calculate the DTI ratio
It’s pretty easy to calculate your own DTI, but there are online tools that will do this for you automatically and track it as well. For example, Intuit’s recently released Turbo app tracks your credit score, but it also tracks your DTI and gives you personalized advice. If you are already a TurboTax or Mint.com user, you can use your credentials to try Turbo yourself.
Bankrate also has a useful DTI calculator . But if you want to do the math yourself, it’s simple:
“The DTI is a simple formula. Divide your monthly debt obligations by your monthly gross income and multiply that number by 100, ”says Lowry, who has partnered with Turbo.
For example: Let’s say you pay $ 200 a month in student loans, $ 850 in rent, and $ 120 in car loans. Your monthly gross income is $ 3,500.
($ 200 + $ 850 + $ 120) ÷ ($ 3,500) = 0.3342 Then x 100 = 33.42%
When you apply for a mortgage, keep in mind the so-called ratio of your household in addition to the DTI ratio (which can also be called your internal ratio). Your Household Ratio is the sum of your household expenses. (including real estate tax, prospective mortgage, insurance, etc.) divided by your monthly income.
“While mortgage lenders usually look at both types of DTIs, the internal ratio often has a greater impact because it takes into account your entire debt burden,” says Nerdvallet.
The “ideal” DTI ratio
Ideally, you should maintain a DTI of 36% or less, Lowry said. At the very least, this is the approximate figure that lenders look for when deciding on your creditworthiness. According to Nerdwallet, mortgage lenders also prefer the household ratio, which is even lower.
“Lenders tend to focus on the background rate for conventional mortgages, loans that are offered by banks or online mortgage lenders, rather than a government program,” they say. “If your front-end DTI is below 28%, that’s great. If your internal DTI is below 36%, that’s even better. ”
Of course, you should aim for a DTI of 0% if your goal is to be free of debt. Either way, this is another number to keep track of besides your credit rating.