Understanding The Crucial Role Of Debt-To-Income Ratios

It’s something lenders usually look into in every loan application. Your debt-to-income ratio plays an important role in getting an approval for your application.

Aside from having a credit score requirement, proof of employment, proof of income, and some others, your DTI ratio is usually part of the equation for your loan approval. Why is it important? We’re about to tell you why. But first, let’s cover some of the basics.

What is a debt-to-income ratio?

A debt-to-income or DTI ratio is a comparison of your debt to your income. Your debt usually includes your monthly credit card dues, existing loans and housing expenses. Your income, on the other hand, includes the gross amount of money you make per month.

To get the ratio, your gross monthly debt is divided by your gross monthly income. For example: If you need to pay $300 for your car loan, $200 for your credit card dues, and $1,000 in rent, your monthly debt payment would total $1,500.

Suppose your gross monthly income is $5,000. Dividing $1,500 by $5,000 would be 0.3. Multiply that by a hundred to get the percentage and your DTI ratio is 30%.

Why is your DTI ratio important?

Lenders give as much importance in looking into your debt-to-income ratio as your credit score. They’d see how well-balanced your debt and income are. If your ratio is quite high, it means that you have too much debt in your hands compared to your gross income.

This is usually a deal breaker for most lenders. If they see that your DTI ratio is too high, they would think that you can’t manage your debts well. Generally, a borrower can have as high as a 43% DTI ratio and still qualify for a loan. Having anything higher would usually be a little more difficult to qualify.

How do we keep our DTI ratio low?

For most cases, paying more than your usual monthly debt obligations can significantly lower your total debt faster. Other than that, try not to rack up more debt especially on credit cards and loans. That would only spell more trouble for you.

Overall, handling your finances responsibly is key. Always be a smart spender. If you keep it up, you can quickly see your improvements in no time.

What if my ratio remains high?

This is a good time for you to look for other loan options. Conventional loan lenders typically have their own debt-to-income ratio standards but there are home loans that have a more flexible DTI requirement.

For example, non-qualified loans could allow borrowers to apply for a mortgage even if their debt ratio is higher than 43%. As long as their other affairs are satisfactory, this would not be much of a problem.

It might be easy to wonder about the risks that these non-qualified mortgages entail but the Ability to Repay rule adds a layer of protection to lenders by minimizing the risk of defaulting borrowers. Therefore, even if this type of loan is quite forgiving when it comes to qualifying, lenders would have to ensure that their borrowers have the ability to pay their mortgages responsibly.

Like other guidelines and qualifications, standards still vary by lender. Other than making a good impression with your DTI ratio, there are other factors that qualifying for a loan entails.

As a loan applicant, make it a point to consult more than one lender, find the right kind of mortgage that fits your situation, and then choose the best offer for you.