If you are meticulous about your finances, you know how essential your debt-to-income ratio is. In many cases, lenders use this ratio to evaluate the health of your financial situation and determine your eligibility for a loan.
The good news is that calculating the debt-to-income ratio is not a complicated procedure. You simply divide your total debt with your total income and convert it to a percentage. Simple right? What’s even simpler is understanding your debt-to-income ratio’s significance on your finances.
This article highlights the importance of a good ratio and how it can affect other aspects of your finances. Additionally, we will highlight how you can correct a bad debt-to-income ratio. Let’s dive in!
What Is a Debt-to-Income Ratio(DTI)?
The debt-to-income ratio or DTI ratio measures your total debt load against your income. Usually, when you apply for a car loan or mortgage, the lender uses your current DTI ratio and your credit score to determine whether you can repay the loan on top of the other existing debts.
If it is good, they will likely approve your loan request, but it may be harder to get the loan if it is bad.
Why Is DTI Ratio Important?
Understanding your DTI is essential for your finances as it helps you adjust your budgets and spending habits accordingly.
When your DTI ratio is high, you’ll have less money for essential household items after paying debts. Plus, it is an indication that you may have trouble with your finances when an unexpected expense comes along.
In addition, your DTI ratio helps you understand your position before taking on new debt, allowing you to manage your existing debt obligations better.
PRO TIP: There is no standard DTI ratio requirement for all lenders. They each set their requirements.
What Is an Acceptable DTI Ratio?
A general rule of thumb for the DTI ratio is that the lower the ratio, the better. A DTI ratio of 36% or below is seen as a wise target by many lenders. And it is in the maximum range for eligibility for a qualified mortgage.
Here’s a breakdown:
· A DTI ratio of 36% Or Less
A debt-to-income ratio of 36% or less often indicates that you have a healthy source of income. You can finance your expenses comfortably and still meet your monthly debt obligations.
Most lenders will consider you as a safe bet as you can afford monthly payments for a credit line or a new loan.
· A DTI ratio of 36% to 42%
DTI ratios between 36% to 43% are a cause for concern for lenders. Yes, they suggest that you have manageable debt levels in comparison to your income. However, you may have a hard time getting a loan, especially larger loans.
Lenders may advise you to pay down some of your debt and reduce your DTI before approving.
· DTI ratios between 43% and 49%
Debt to income ratios between 43% and 49% often suggest that you have problems paying off debt. It is hard to convince lenders that you can meet debt obligations if they decide to give you another loan.
· DTI Ratio of 50% or Higher
A DTI ratio of 50%or higher means that you struggle a lot to make debt payments and have a high chance of missing payments or defaulting. Plus, your borrowing options are limited, and paying it down may be a difficult task to undertake.
To get a new credit line, lenders will ask you to increase your income or reduce your debt levels.
