Debt to Income Ratio: Judging its importance in your life

DTI or the debt to income ratio is considered to be a fiscal measure which plays as crucial a role in your life as your credit scores do. How? Let us find it out in this post. The DTI measure is utilized to compare a person’s debt obligations with respect to his overall earning. Very simply, the debt to income ratio can be calculated in the following fashion:

Monthly Earning= $10,000

Monthly Debts: $ 2,000

Debt to Income Ratio thus stands at 20% (you simply divide 2000 by 10,000)

Please remember that your DTI is based on your monthly income, considering it is your major source of earning. It is your gross income (before your taxes and insurance are deducted from your salary) which is taken into account while your DTI is calculated. We will be delving into further details of debt to income ratio but not before explaining why it is treated as important a factor as your credit scores.

Debt to income ratio and mortgage

Your DTI is a measure used by mortgage lenders to ascertain whether, at all, you will be granted a mortgage loan or not. If you are approved for the loan, your DTI will once again be taken into account to determine the total amount of loan that you will be granted. It helps the lenders find out your leftover earnings after you have met all your financial obligations. This income will actually be available for making your mortgage payments every month. You need to meet a certain ratio to qualify for the loan.

A DTI ratio of 30 – 35 percent is considered ideal for securing mortgage loans on desirable terms. However, if your number hovers over 36 to 40 percent then it would be considered that you will have considerable difficulties in making the payments on time.

The calculations

As far as your income is concerned, here are the factors which are considered, besides your monthly paycheck:

  • Government assistance or benefits
  • Regular earning from child support
  • Alimony
  • Earnings from side business
  • Other miscellaneous earnings
  • Tips and commissions

Your debt numbers include

  • Student loans
  • Mortgage (property tax, association fees, insurance, private mortgage insurance)
  • Rent
  • Minimum credit card payment
  • Legal judgment
  • Credit card dues (minimum)

Please remember that your debt numbers will not include factors like clothing, food bill, and entertainment bills or for that matter, informal loans. Your lender will be utilizing two types of ratios in a bid to evaluate your credentials for securing the loan.  The front end ratio entails only your housing expenses while the second factor to be considered is your recurring debt. The recurring debt is taken into account in order to ensure that you are still able to pay for everything else after paying the interests of your new loan. Keeping your debt ratio low not only helps you grab greater mortgage deals but also bolster your savings. If you are paying a lesser amount in debts you are getting to save more.