Lenders of all sorts need to have their figures and facts lined up before they’ll even consider lending out money to just anyone. One of the most important numbers they’ll learn about you is your Debt-to-Income Ratio. As a metric, it helps them understand a lot about how fiscally responsible you are. However, to the average person, that number doesn’t mean a whole lot. What does debt-to-income mean? What is a good ratio to have? How can I change that number if it’s not right? Luckily, we’re here to break it down quickly and easily
What Does Debt-to-Income Mean?
Essentially, debt-to-income is a measure of how much of your income goes to paying off debts. Essentially, DTI is calculated as your total monthly debt payments divided by your gross monthly income – or the amount you make from every source. These debts can come from a variety of sources, including credit cards, loans, and mortgages. The result of this calculation leaves you with your DTI as a percentage, in which companies look at face value. A higher DTI means that you pay more of your income to pay off debt, and lower means less of the same.
As an example, let’s say that you make $3,000 per month. If your credit card payments average to around $150, student loans take another $250 every month, and car payments are $300 – that leaves you with a debt of $700. Dividing those numbers, we find a Debt-to-Income ratio of 23%.
What is the “Right” Ratio, and How Do I Get There?
The generally accepted threshold for a “good” ratio to have is around 36%. Anything lower than that is something that’s appreciated by lenders of all kinds. Lenders tend to interpret higher DTI ratios as a risk factor. Someone that has a lot of debt compared to their income may find themselves having trouble paying back the money they owe. In most cases, borrowers won’t find anyone willing to take that risk for a DTI any higher than 43%.
Working on reducing your DTI is a challenge. Mathematically speaking, though, the best way to lower that number is to reduce your debt payments or increase your income. For the former, your options lie in paying off your debts before going for a mortgage, consolidating or restructuring your debt for lower payments, or reducing the usage of your credit cards. Increasing your income is different, but a much more direct solution. Many people opt for taking a second job/shift, finding a side project (usually freelancing), or selling items online. Managing your financial life is work, but it’s work you can profit from – literally.
Financial Growth, One Step At a Time
Understanding your DTI and how that number applies to your life is essential, but just one small step. The whole mortgaging process is vast and nuanced – and it’s hard to know if you’re doing the right thing sometimes. First Choice Mortgage wants to relieve that stress as much as possible and be there for you through the whole process. Our Learning Center offers information on the basics about many steps along the way. For more questions and inquiries on starting the mortgaging process, contact us today!