# Debt-to-income ratio’s

The ratio debt-to-income calculation shows how much of your monthly income goes to debt payments. This information helps both you and lenders find out how easily you can cover your monthly expenses. Along with your credit scores, your debt-to-income ratio is one of the most important factors for getting approved for a bank loan.

## The calculation

If you want to calculate your current debt-to-income ratio, add up all your monthly debt payments and divide your gross monthly income from your total monthly debt payments. You can also make a calculation to estimate how much your monthly debt payments should be in relation to your income.

Multiply your income by a target debt-to-income level, such as 30 percent, and use the resulting debt percentage to guide your debt repayment strategy if you are looking to qualify for a future loan.

### Monthly debt payments below the required minimum payments for all your loans, including:

• car loans
• Credit card debt
• Student grants
• Mortgage
• Personal loans

The gross monthly income used in the calculation is equal to your monthly salary before any taxes or other deductions are taken out.

### A few examples

Suppose you have a monthly gross income of \$ 3,000. You also have a car loan payment of \$ 440 and a student loan payment of \$ 400. Calculate your current debt-to-income ratio as follows. Divide the total of your monthly payments (\$ 840) into your gross income: \$ 840 debt payments / \$ 3,000 gross income = 0.28 or 28 percent debt-to-income ratio.

Now, assume you still earn \$ 3,000 a month gross, and your lender wants your debt-to-income ratio to be over 43 percent. What is the maximum that you have to spend on the debt every month? Multiply your gross income by the target debt-to-income ratio: \$ 3,000 gross income * 43 percent target ratio = \$ 1,290 or less per month target for debt repayments Any amount of debt payments lower than the target would be ideal and a lower number would improve your chances with your banker.

## Which qualifies as a good Ratio

Banks and other lenders use debt-to-income ratios to measure affordability. Lenders want to be sure that you can comfortably report to your existing debt payments, especially before they approve new loans and increase your debt.

The specific numbers vary per lender, but many lenders use 36 percent as the maximum debt-to-income ratio. That said, many other lenders will let you go up to 55 percent. Lenders can look at two different variants of the debt-to-income ratio. When we look at payments, they can look at a front-end ratio, which only considers your housing costs, including your mortgage payment, property taxes, and homeowner’s insurance. Lenders often prefer to see the ratio at 28 percent to 31 percent or lower.

## A back-end ratio of income to the total debt ratio looks at all your debt-related payments.

This means that you would include car loans, student loans and credit card payments. For your mortgage on a qualified mortgage, to be the most consumer-friendly loan type, your overall ratio must be less than 43 percent. This rule has exceptions, but federal regulations require lenders to show that you have the option to repay a home loan they approve, and your debt-to-income ratio is an important part of your assets.

You are the ultimate judge of what you can afford. You don’t have to borrow the maximum available to you, and it’s often better to borrow less. Borrowing the maximum can put a strain on your budget, and it’s harder to absorb surprises such as a job loss, change schedule, or unexpected costs. Keeping your debt payments to a minimum also makes it easier for you to transfer money to other goals, such as education costs or retirement.

If your debt-to-income ratio is too high, you must bring it down to get approved for a loan. You have different ways of achieving this, although you need a certain amount of strategic planning and discipline.

• Pay off debt: This logical step can lower your debt-to-income ratio because you will have smaller or fewer monthly payments included in your ratio. Paying credit card debt aggressively allows you to cover lower mandatory monthly payments.
• Increase your income: Any additional work you can take before borrowing can help. All the income does not have to be yours, however. If you apply for a loan with a spouse, partner or parent, their income and debts will also be included in the calculation.
• Of course, that person will also be responsible for paying off the loan if something happens to you. Adding a cosigner can help you get approved, but be aware that your cosigner is taking part of the loan repayment risk.
• Slow down borrowing: If you know you’re going to apply for a major loan as a home loan, avoid getting on other debts until getting your home loan financed. Buying a car just before you get a mortgage will hurt your chances of getting approved because the big car payment counts against you. On the other hand, it will be harder to get the car after you get a mortgage, so you’ll have to set priorities.
• Bigger down payment: A large down payment ensures that your monthly payments are lower. If you have cash available and can afford to transfer it to your purchase, see how it would affect your ratios.

Lenders calculate your debt-to-income ratio using income that you report to them. In many cases you need to document your income, and lenders must be confident that you can continue to earn that income for the duration of your loan.

## Your debt-to-income ratio is not the only thing that lenders consider.

Another important ratio is the loan to value ratio (LTV). It looks at how much you borrow compared to the value of the item you purchase. If you cannot put down money, your LTV ratio will not look good.

Credit is another important factor. Lenders want to see that you have borrowed, and more importantly, the repayment of the debt, for a long time. If they are convinced that you have handled your debt properly, they are more likely to get you a loan. They will look at your credit history and scores to evaluate your lending history.