In addition to the credit score and credit report, your debt-to-income (DTI) ratio is another important factor in your overall financial health. The debt-to-income ratio is the percentage of your gross monthly income that goes to paying your monthly debt and is used by lenders to determine the risk associated with you taking on another credit.
How to Understand Debt-to-Income Ratio?
Lenders use your debt-to-income ratio along with the credit history to estimate your ability to afford repayment and to pay off the debt.
The debt-to-Income ratio of 35% or less means that your debt is at a manageable level relative to your income. This debt-to-income ratio is favorable to lenders as you most likely have remaining money after you’ve paid your bills.
If your ratio ranges from 36% to 49%, you are managing your debt adequately, but you may want to consider lowering your DTI Ratio to obtain the loan or line of credit you want on better terms.
With more than 50% of your income going toward debt payments, you may not have much money left to save, spend or handle unforeseen expenses. With this DTI Ratio you become less attractive to the lenders, thus they may limit your borrowing options.
The maximum DTI Ratio varies from lender to lender. However, the lower the debt-to-income ratio, the better chances that you will be considered and then approved for the credit application.
How to Calculate Debt-to-Income Ratio?
To calculate your DTI Ratio, add up your minimum monthly debt payments then divide the total by your gross monthly income.
Debt includes your regular monthly payments on personal, student, car loans, mortgages or any other type of loan. Your monthly minimum credit card payments also count as debt, as do unpaid bills sent to collection agencies.
Your gross monthly income is the sum of everything you earn per month before taxes or deductions are imposed. This includes your basic monthly income and any additional commissions, bonuses and investment income that you earn each month. To calculate your gross monthly income, take your total annual income and divide it by 12 months.
How to Lower Debt-to-Income Ratio?
In order to get a loan on more favorable terms, you may want to lower your debt-to-income ratio. There are two ways to do that: by reducing your monthly recurring debt or by increasing your gross monthly income. Also, debt consolidation may help you get a better interest rate and pay down your balances sooner, as well as help lower your debt-to-income ratio.
Thus, the debt-to-income ratio is another aspect that speaks of your financial well-being, which is considered by lenders when issuing various types of credit lines and loans. The debt-to-income ratio requirements can vary depending on the lender and the type of loan or credit you want to apply for. According to the specified algorithm, you can calculate your percentage and, if necessary, take certain measures in order to improve it.
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