The home buying experience can be an overwhelming experience that can be exhilarating, fun, stressful and exhausting. The process of securing a mortgage, successfully bidding on a home and completing the transaction can be lengthy, complex and involve seemingly endless professionals. Those professionals may include a buyer’s agent, a loan officer, a home inspector, title […]
What is a debt-to-income ratio, and how can you improve it?
DTI ratio, or debt-to-income ratio, is the amount of debt you pay off each month in relation to your gross monthly income. This number lets your lender know how much of your overall income will be available to cover your mortgage and is represented as a percentage. For example, if 50% of your income goes to debt payments, you’ll most likely need to reduce debt before taking on the financial responsibility of a home.
Lenders use your DTI ratio to determine your eligibility for a home loan. If your DTI ratio is on the higher side, here are four tips to improve it:
Have a realistic budget
Keeping a realistic budget will help you be responsible with money and prevent monthly costs from increasing your DTI. Take into account not only your debt payments but also recurring expenses such as:
- Car insurance
- Homeowner expenses
Regularly calculate your DTI ratio
Regularly calculating your DTI ratio will keep you on track and show you how you are progressing. It will also motivate you to keep your debt manageable when you see it fall.
When calculating DTI, do not include monthly living expenses such as utilities, car insurance, and groceries. Use the following formula:
Monthly debt payment / Gross monthly income = Debt-to-income ratio
Pay off debt responsibly
Responsibly paying off debt means, at the very least, paying the minimum amount you owe each month. When possible, put more money towards monthly debt payments to help pay it off faster. Remember only to do so when you can afford it. You want to use something other than the money you need for groceries and utility bills.
Consider consolidating your debts (especially if you have multiple student loans), so you only have one monthly payment.
Don’t take on more debt before a home purchase
If you want to purchase a home, avoid taking out more debt. This means avoid large purchases like cars, boats, or furniture financing. Since DTI helps lenders determine how much you have available to pay for a home loan, you don’t want to increase your debt while planning to take out more debt. .
While getting a home loan that works for you and your DTI ratio is possible, you should lower it and save up before purchasing a home to ensure you are comfortable, and prepared to take on the financial responsibility of a mortgage payment.