Understanding The Financial Influence Of Debt-To-income Ratio
Your debt-to-income ratio may hinder your chances of getting a mortgage approved by banks or lenders. We explore everything you should know about it to take the necessary steps to improve it.

Getting a mortgage has become easier than ever. However, finding a good mortgage and getting it approved can be tricky. The difference can mean tens of thousands of dollars in savings over the term of your mortgage.

While banks and lenders look at dozens of things before, they approve your mortgage, one of the key things they consider when making their decision is your debt-to-income ratio. If it’s too high, they may reject your application.

So why take a chance with your mortgage applications? We explore the debt-to-income ratio and you understand what it is and how you can calculate it, so you can improve it and not take any chances.

 

What Is The Debt-To-Income Ratio?

The debt-to-income ratio is a personal finance metric and an indicator that helps lenders determine your creditworthiness. It is a mathematical comparison between your “debt” and your “income” calculated as a percentage. It can be written as a percentage or as a ratio.

It is an easy and accurate way of telling lenders how well you have your personal finances in order and how prepared you are to take on a mortgage responsibly. Banks and lenders wouldn’t want to loan large sums of money to someone when they have mathematical evidence to show that that person cannot afford to make timely payments.

 

How To Calculate Your Debt-To-Income Ratio

Dividing your total monthly debt payments by your gross monthly income will get you your debt-to-income ratio. This will give you a “ratio” of your debt-to-income, which you can further multiply by 100 to get the debt-to-income “percentage”.

For example, let’s say your total monthly debt payments include a $500 monthly car payment, $500 monthly credit card payment, $300 monthly student loan payment, and a $1,200 dollar housing payment that includes taxes, mortgage, etc.

This brings your total monthly debt payment to $2,000. If your gross monthly income is $4,000, your debt-to-income ratio becomes 0.5 (2000/4000 = 0.5), or a debt-to-income percentage of 50% (0.5×100 = 50).

Generally, this would be considered a relatively high debt-to-income ratio, which may prevent you from getting your mortgage approved or even a loan or refinancing. So, how can you improve your debt-to-income ratio?

 

Increase Gross Monthly Income

If you earn more, you can increase your gross monthly income and improve your debt-to-income ratio. Taking the previous example, if you make $6,000 instead, your debt-to-income ratio becomes 0.333 (2000/6000 = 0.33) or 33.33%, which is a significant improvement.

 

Reduce Your Debts

Similarly, you can reduce your debts to have the same effect on your debt-to-finance ratio. For example, if you completely pay off the car loan, your total monthly debt becomes $1,500, which means your debt-to-income ratio will be 0.375 (1500/4000 = 0.375) or 37.5%.

 

Refinance

Refinancing is another option. For example, you may be able to refinance your student loan at a lower interest rate or longer term. This will reduce your monthly student loan payments and improve your debt-to-income ratio.

Ultimately, regardless of whether you want to get a mortgage/ loan approved or not, knowing your debt-to-income ratio is important to help you understand your personal finances better. It allows you to make the necessary changes that help improve your creditworthiness and financial standing.

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