Understanding Debt to Income Ratio

Debt to income ratio is one of the most significant indicators that define your financial health. Simply put, this denotes how much you can afford. This tells you the percentage that goes to your monthly debts or payments against your monthly income. Financial experts agree that the debt to income ratio should be below 36%, ideally at 30%.

Calculating Debt to Income Ratio

There is an easy way to figure out your debt to income ratio. What you need to do is to take your total income for one month and multiply it by 36%. For instance, your monthly gross income is $2,500. You will have to multiply this amount by .36 to get the debt to income ratio. Using the given equation, $2,500 x .36 is equal to $900. What this means is that your debt repayments should not go beyond $900 every month. As you can see, the amount that you get or the ratio will serve as your guide in determining your comfortable debt repayment capacity.

Two Types of Debt to Income Ratio

Knowing your debt to income ratio allows you to define how much of your income should go to your PITIA. PITIA stands for principal, insurance, taxes, interest rates, and (homeowner) association fees. Debt to income ratio generally comes in two different forms:

•  Front End – This denotes that your debt to income (DTI) ratio is based on your first mortgage payment. President Obama has set a foreclosure prevention program that states that the front end debt to income ratio should only be 31%.
• Back End – All your other month debt payments are included in the back end DTI ratio. These include your home equity credit line or your second mortgage, your credit card payments, and other loan payments.

Back end debt to income ratio is a huge determinant of your monthly repayment capability. To get your percentage in this category, you will need to add up all your monthly debt statements. Then you will need to divide the sum by your monthly gross income. If your debt to income ratio is too high, there are a few things that you can do to improve it. Basically, you have two options:

• You can either lower your expenses, or
• You can increase your monthly revenues.

Having a much better salary can be hard. However, this does not mean that this is impossible to achieve. There are several ways to obtain this goal, including taking a part time job and asking for a raise if you qualify for it.

Why You Should Improve Your DTI

Lenders take a look at your debt to income ratio. Therefore, if you are planning to get a loan, a credit card, or other credit line, this will be considered in determining whether you are approved or not. If you have high DTI, this means that you are overburdened with loans or debt. This can also be a signal of debt evasion. Although your debt to income ratio is not the only thing that lenders examine for your application, this is a crucial factor in loan approval.