What is debt to income ratio?

Debt to Income Ratio or simply DTI, is the percentage of your gross income that goes towards paying your bills or other debts. To be precise it also covers fees, taxes, insurance premiums and other monthly bills. It one of the important indicators that financial institutions and lenders look before offering you loans. Your debt to income ratio helps to evaluate your creditworthiness.

It is calculated by the formula: Debts/ Gross income.

Say, for example if your gross income is $10,000 and you need to pay $2000 for your debts then, your DTI is 20%

What are the types of Debt to Income ratio?

There are two types of DTI; they are front- end DTI and back end DTI.

• Front-end DTI: It includes only your monthly expenses like your mortgage payments, property taxes, homeowner’s insurance payment, and homeowner’s association dues.

• Back-end DTI: This includes all your monthly payments and the debts listed on your credit report. Every lender has different requirement of back-end DTI limits. The maximum limit can go up to 45 % but some lenders also consider up to 40- 50% of back-end DTI limits.

What debt to income ratio is acceptable?

An acceptable DTI should be below 15 %. A ratio above 20% should be taken care of, as it signals a need to control over your expenses. The smaller ratio you have, the better is your financial condition. A high debt to income ratio means your debts are becoming unmanageable and it might hold your loan application back.

What is the importance of Debt to Income Ratio?

Your debt to income ratio is an important figure through which the lenders can decide how well you manage your debts. It is also a factor through which the lenders can determine what rate of interest to be offered to you, and on what loan terms. In short, it is the snapshot of your financial condition which helps in getting your loan applications approved.

You should remember that DTI consists of what your monthly debts will be after you get a loan. It does not include your current debts. So, those debts which you will pay off are not included in DTI. Most of the lenders measure your current monthly debts like credit card bills, car payments and any other types of loan and add it in your future mortgage payment. If the sum of your current and mortgage debt is too high then you may face problems in getting loans. So, overall a low debt to income ratio helps you to negotiate with your creditors for better rates of interest and higher amounts of loan.