The debt-to-income ratio indicates how much of your monthly gross income goes in paying debts. This ratio also covers taxes, fees and insurance premiums. It is an important personal finance measure which compares your debt payments to your income. It gives the lenders an idea of how likely it is that you will repay the loans. The higher the ratio the greater is the burden which you have to bear to make the repayments. If the ratio is too high it may be difficult for you to access other types of financing. This personal measure is as important as the credit score.
Importance of the ratio
The debt-to-income ratio will help to get a clear picture on what your financial situation is. It will help you to understand the true financial picture. You will not have to shell out a penny to calculate this ratio. You need to spend just a minute to calculate this personal finance ratio. You can update yourself on ways in which you can improve your financial situation which will automatically increase the debt-to-income ratio. By improving this ratio you can increase your chances of getting a mortgage and applying for a better car loan. You may also have an access to better credit card rates.
When a debt-to-income ratio is calculated the amount of debt which you incur in the form of car loan, mortgage, credit card debt and student loan is compared to the overall income which you receive. This calculation will help you to calculate the debt load in comparison to your income. While doing this calculation you must not include expenses on groceries, gas and utilities. You can also make use of a debt-to-income ratio calculator for accurate results. Although this ratio is not as popular as accredit score they can play a vital role when you apply for a loan.
Used by lenders
The banks and lenders use this financial tool to assess whether they will lend money for mortgage or loan. Other factors like your employment history and credit score will be taken into account by lenders. However if you have a good debt-to-incomes ratio you can offset other factors which are not favourable. You can easily negotiate on other factors. If you are financially strong you have the leverage to negotiate on the interest rates of loans which are offered by the lenders. These are the various advantages which you can enjoy by keeping the debt-to-income ratio low.
Two types of debt-to-income ratio which are used are front-end-ratio and back-end-ratio. Front end ratio calculates the amount which you pay as monthly rent. It is that percentage of your income which is used to pay mortgage principal and interest. Back-end-debt ratio is the amount of income which is used to pay car loans, credit-card payments, student loans and personal loans. Lenders will use this ratio to find whether you qualify for this loan. There are two important ways in which you can improve your debt-to-income ratio. You can improve your income or reduce your debts. In this way you can have a greater amount of money to work with.
With this important indicator you will be able to ascertain whether you have enough cash flow to meet your financial obligations. There are several ways in which you can lower a high debt-to-income ratio. You can increase your income by working overtime. You can ask for salary increase or work part-time to improve your income. The next way to lower high DTI ratio is to pay off the debts. If you pay off the debts your DTI will drop.