Debt to income ratio – An important factor in getting a loan

If you want to buy a home or a car for yourself on loan, the most important factor the lender will consider, before approving your loan application, is your debt to income ratio (DTI). So, prior to applying for a loan, you should calculate your own dti and know whether or not you are eligible to get a loan.

What is debt to income ratio?

Debt-to-income-ratio or DTI is a measure of your personal finance in percentage that measures the amount of money you earn to the payment you make for your debts every month. Higher is your debt-to-income-ratio, more will be the amount you are required to pay. Having a higher ratio may narrow down your chances for getting qualified for a loan.

Debt-to-income ratio basically consists of two kinds of numbers, mentioned below:

  • The front-end ratio: This ratio is calculated by the total housing expenses like, mortgage payments, principal, mortgage insurance, interest, as well as, property taxes, premium for hazard insurance and also dues of homeowners association, if applicable, dividing by your gross income. To get qualified for a mortgage, your front-end DTI ratio should be less than the indicated level. Higher will be the ratio, less will be the chances of getting approved for the loan.
  • The back-end ratio: This ratio calculates your total expenses towards debts, like, credit card debts, mortgage debt, other loans, child support, alimony, etc. The lender considers both the ratios to approve your loan application.

What is the qualifying limit with debt-to-income ratio?

Generally, a standard guideline for debt-to-income ratio is set on the basis of the loan program. In the US, the limits for Federal Housing Administration loans are 28/36. However, for Veteran Affairs, limits are 31/43. However, the ratio requirement may vary from one lender to another.

How to calculate your debt-to-income ratio?

You can calculate your debt-to income ratio, by following the 3 steps mentioned below.

1. Calculate your total income and expenses: You should first calculate your total monthly take-home income. This includes your salary, commissions, bonus, other payments, etc. You should also calculate your total debt obligations in a month. This will include payments towards credit cards, mortgage payments, or any other loan.

2. Divide monthly debt expenses by income: After this, you should divide the monthly debt obligations by total monthly income. This will give you the debt-to income ratio.

3. Express it as percentage: Your debt income ratio is generally expressed as percentage. The lower will be the ratio, the higher will be the chances of getting the loan. A DTI of 28/36 is the standard debt-to income ratio and most of the lenders will accept this figure.

Why debt to income ratio is important?

Debt-to-income ratio is important because:

  • It keeps track of your financial health
  • It shows your credit worthiness
  • It calculates your mortgage affordability

Debt to income ratio is an important factor that determines your eligibility for getting approval for a mortgage loan. It indicates your financial responsibility and credit worthiness. So, it is very much important to maintain this ratio.