What is your debt and income ratio?
17 AUGUST 2023
Your debt-to-income ratio (DTI) compares your monthly debt expenses to your gross monthly income. Learn how to calculate your DTI.Your debt-to-income ratio (DTI) compares your monthly loan payments to your monthly income. It refers specifically to the portion of your gross monthly income (before tax) that is used to pay off debts like rent, a mortgage, credit cards, and other obligations.
Is it better to have a high or low debt-to-income ratio?
A low debt-to-income (DTI) ratio indicates that debt and income are well balanced. In other words, a DTI ratio of 25% indicates that 25% of your total monthly income is used to pay off debt. In contrast, a high DTI ratio can indicate that a person has too much debt relative to their monthly income. Borrowers that have low debt-to-income ratios are typically better able to handle their monthly loan payments. As a result, before offering a loan to a potential borrower, banks and financial credit providers prefer to see low DTI percentages to make sure a borrower isn't overextended.
The DTI ratio is just one financial ratio or measure used in the decision making process for credit, despite its significance. The decision to grant credit to a borrower will also take into account the borrower's credit history and credit score. Your ability to repay a debt is expressed numerically by your credit score. Late payments, delinquencies, the number of open credit accounts, the balances on credit cards in relation to their credit limits, or credit utilisation are some characteristics that might have an impact on a score.
The DTI ratio does not account for the expense of servicing different types of debt. Although credit cards have higher interest rates than student loans, they are combined when determining the DTI ratio. Your monthly payments would go down if you switched your balances from credit cards with high-interest rates to ones with low-interest rates. As a result, your total monthly loan payments would go down and your DTI ratio would go down, but your overall debt would stay the same. When asking for credit, it's crucial to keep an eye on your debt-to-income ratio, but lenders consider other factors as well when deciding whether to grant you credit.
What is a good DTI?
The maximum DTI ratio a borrower can have and still get approved for a mortgage is 43% as a general rule. Lenders prefer a debt-to-income ratio that is less than 36% and one where no more than 28% of that debt is used to pay a mortgage or rent. The maximum DTI varies depending on the lender. The borrower's prospects of being authorised, or at least given consideration for, credit is, nevertheless, better the lower the debt-to-income ratio.
How to calculate your DTI
1. Add up your debts
You will add up your regular monthly payment for loans with set payments, such as a personal loan, car payment, or rent. For variable payments like credit cards or a home loan, use your minimum monthly payment. Any debts reported on your credit report will be included in your monthly debt payments. You will calculate your mortgage payment using the full PITI (principal, interest, taxes and insurance).
2. Calculate your income
The next step is to total your gross monthly income. Think about your entire income. Your lender will probably demand proof of your income when you submit an application for a loan. You must also calculate this if you own any properties that you rent out. Your monthly financial obligations include the mortgage payments for your rental units.
3. Divide your monthly debts by your monthly gross income.
For example, you would divide your monthly debt payments (R3 000) by your total monthly gross income (R10 000). In this case, your total DTI would be 0.3, or 30%.
Your DTI has the power to make or break your loan application. It will not only aid in your loan eligibility but could also result in a lower interest rate. Increasing your income, cutting expenses to make greater debt payments, or consolidating debt at a reduced interest rate are some ways to lower your DTI.