Many people don’t realize that debt-to-income (DTI) ratio is an important part of a person’s overall financial health. And because it’s important to keep track of your financial status, calculating the DTI may help determine if one’s comfortable with current debt load and if applying for additional credit is the right choice for them.
When you apply for credit lenders review your DTI to decide if you can afford to take on more debt and an additional payment. The debt-to-income ratio is an important number to monitor. That’s because it tells you a lot about how precarious or stable your financial situation is. The debt-to-income ratio is an important measure of your overall financial security.
From the perspective of creditors and lenders, the DTI is an important measure that they use to assess risk. People with higher debt-to-income ratios are more likely to default on their debt.
The debt-to-income ratio is a number that expresses the relationship between your total monthly debt and your gross monthly income. Please check out the formula below:
If 43% is the maximum debt-to-income ratio you can have while still meeting the requirements for a debt, what counts as a good debt-to-income ratio for general purposes?
Usually, the answer is a ratio at or below 36%. A DTI of 36% gives you more breathing room than a DTI of 43%, leaving you less vulnerable to a negative impact if changes in your income and expenses accordingly occur.
In the instance where you’re applying for a particular loan, improving your debt-to-income ratio can make a huge difference in how lenders view you in terms of lending.
Several steps can help you achieve a lower DTI, including:
Since income does not appear on your credit report and is not a factor in credit scoring, your DTI ratio doesn’t directly affect your credit report or credit scores accordingly.
However, while your income is not reported to credit bureaus, the amount of debt you have is directly related to multiple factors that do affect your credit scores, including your credit utilization ratio. It’s best to keep your debt low from the get-go, than try to recover from a difficult situation. If your DIT is at the acceptable ratio then so many doors will be open to you!
Excerpt: When it comes to approving a loan, lending institutions are very vigilant and use many instruments to check the borrowers’ profiles. Debt-to-income ratio is a top indicator in this sense. Learn how it works.