There are many factors that lenders consider before deciding to loan you money, and one of them is your debt-to-income ratio (DTI). This ratio is calculated by comparing your monthly debt payments to your monthly income. You may be wondering, “Why does my debt-to-income ratio matter?”
Why Lenders Look at Debt-to-Income Ratio
Besides looking at your credit history, lenders consider your income and how much of what you earn is going toward paying back debt. When they calculate how much of your income is already being spent on bills and how much is left over, they can get a pretty good idea of how likely it is that you’ll be able to pay a loan back, or whether you’ll have difficulty making payments.
Two Types of Debt-to-Income Ratios
Debt-to-income ratios are especially important when you’re applying for a mortgage because mortgage lenders often look at two different kinds of DTI. First, they’ll look at front-end DTI, which is the percentage of your income that goes to housing expenses. This includes not just the mortgage but also homeowners’ insurance and property taxes. Ideally, your front-end DTI should be no more than 28 percent of your income.
Your back-end DTI considers all your debt payments, not just your housing expenses. It will add together housing expenses, student loans, car payments, credit card payments, and child support and compare these expenses to your income. Different lenders may have different standards on a good back-end DTI. The lower it is the better. Most look for a DTI of under 43 percent.
What if Your DTI is Too High?
If you didn’t realize that DTI is an important reflection on your financial picture, you may find that your DTI is too high. If it is, look for what can be cut out of your budget and redirected toward your debt. Work on increasing the amount you devote toward your debt each month. Avoid opening new credit cards or loan accounts, and don’t make large purchases on credit that you don’t need. Making extra payments on your debt while avoiding borrowing more money can gradually bring down your debt and approve your DTI.
Improving Your Financial Picture
Bringing down your DTI is just one small part of what needs to be done to improve your financial picture. It’s important to always pay your bills on time. Check your credit report at least once a year to make sure everything on it is accurate. Misinformation on your credit report can bring down your score and make your financial picture look worse than it is. Check that balances are accurate and that none of your accounts are showing late payments if there were none. Make sure there are not any accounts on your credit report that you don’t recognize.
If you do find errors on your credit report, Dovly can help. Dovly is an automated credit repair engine that can help you track, manage, and fix credit, and can dispute errors on your credit report for you. Try it risk-free with our free membership tier. Contact Dovly today.