Understanding Debt-to-Income (DTI) Ratio: What Is It?
Before a person’s loan application gets approved, their lender needs to conduct assessments to ensure that they have a good enough financial standing to repay the loan. Lenders look into specific requirements, and one of them is the Debt-to-Income (DTI) ratio. If you have heard of this term before but do not understand, let this article serve as your primer to the concept.
What Is Debt-to-Income Ratio?
The debt-to-income ratio uses a person’s monthly income and monthly debt payments. It is a personal finance measure used by lenders to assess whether they can pay their monthly dues based on their monthly earnings.
It is typically encountered in mortgage loan applications. Your lender would look at your total debts. In the calculations, the lower the ratio is, the better the balance there is between the two factors. Currently, lenders prefer a DTI ratio of below 36%. This serves as the majority’s maximum total DTI ratio for a borrower’s stable money income. They also prefer it if the 28% in that 36% goes into paying off your mortgage loan. Anything higher than that, and lenders might presume that you have too many debts to pay than your income.
However, that data is only based on the general perception of lenders. The number might still vary depending on the banks and credit providers you talk to. In general, if you have a lower DTI ratio, you have a better chance of your loan application getting approved or considered.
How Is DTI Computed
To understand how lenders compute for the ratio, here are the things you need to know:
Understanding the Terminologies
Gross Monthly Income: The amount of income a person earns in a month before the taxes and the deductions are taken out.
Monthly Debt: This refers to the recurring monthly payments you need to pay off, such as credit card payments, loan payments, child support, and the like.
The Debt-to-Income Ratio Formula is your monthly debt payments divided by your gross monthly income. The answer you get should be in a percentage format that serves as your DTI.
What Is Debt-to-Limit Ratio?
Besides the DTI ratio, you might also hear about the DTL ratio, also known as the credit utilization ratio or balance to limit ratio. The Debt-to-Limit ratio is the metric used by lenders to check one’s creditworthiness. It is calculated by dividing the borrower’s total outstanding debts by the credit limit of the person’s loans.
Lenders determine this to assess how close the loan applicant is to “maxing out” their credit capacity. A ratio of 30% and below is considered the acceptable limit by lenders regarding this aspect. Anything higher than that could mean that the person is having difficulty managing their overall credit and expenses.
Loan applicants always get the advice to aim for a good credit score or standing to qualify for a good loan. These numbers play a significant role in informing the lenders whether to approve or not your application. Now that you know how these details are extracted do what you can to maintain your ratios at the most acceptable level possible.
For the DTI ratio, you can increase the amount you pay monthly toward your debt and avoid taking on more debt. For DTL, paying off your outstanding balance can help you do that. Recalculate your ratios every month and observe how they would improve.
If you are looking for personal or installment loans in Centerpoint, AL, contact us at Parkway Finance. We have helped our local community by giving them affordable, straightforward, fair, and honest loan options. Please call our office at 205-537-0438 to inquire about a loan today.