How to Improve Your Debt-to-Income Ratio | Reed Team Homes

 

How to Improve Your Debt-to-Income Ratio

Your debt-to-income ratio, or DTI, is one of the main things a lender will look at when qualifying you for a mortgage. It’s seen as a good indicator of whether or not a borrower will be able to repay their loan on time and in full each month.

Before we get into how to improve your debt-to-income ratio, let’s talk about how it’s calculated and what ratio to aim for.

How to Calculate Debt-to-Income Ratio

Your DTI is calculated by dividing your monthly debts by your gross income. 

Here is an example of how to find your DTI if you have multiple debt payments due every month:

 Monthly Debt Payments

        Mortgage: $1,500

+        Car loan: $300

+       Student loans: $200

Add these together and your total monthly payment is $2,000.

For this example, let’s say you make $48,000 a year. That’s $4,000 a month in gross income.

To get your DTI, divide $2,000/$4,000 = 0.50, or 50%. That’s on the high side. Lenders prefer your DTI to be under 36%. The lower, the better.

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Improve Your Debt-to-Income Ratio Method #1: Decrease Your Debt

You get the biggest bang for your buck by lowering your debt payments. Sticking with the example above, let’s say you were able to pay off your student loan debt. Now your DTI is $1,800/$4,000 = 45%. If you can pay off your car loan, now you’re at $1,500/$4,000 = 37.5%. That’s very close to the 36% or below that lenders prefer.

Your final step could be deciding to get a slightly lower mortgage, dropping your monthly payment to $1,400. That puts your debt-to-income ratio at 35%, meaning you’re more likely to qualify for the mortgage.

Everyone is in different situations. Some people only have a few debts/balances they can pay off while others may have many. For example, if someone has 4-5 different credit card payments on top of their car, mortgage, and student loans. They will lower their DTI with each credit card they pay off. Causing them to look better on paper for a mortgage.

Improve Debt-to-Income Ratio by Increasing Income

How to Improve Your Debt-to-Income Ratio

Another way of lowering your DTI is by making a bit more money. The impact is less than paying off debt, but it still helps.

Let’s say instead of paying off debts you found a way to make extra money on the side. If you increased monthly income by $200, your ratio goes to $2,000/$4,200 = 47.6%. If you can make $500 on the side, now you’re at $2,000/$4,500= 44.4% for your debt-to-income ratio.

So you can see the number is getting better, but not as quickly as paying off your debts.

Ideally, you would do both – increase your earnings and use it to pay off your debts. Win-win!

What Other Debt-to-Income Questions do You Have?

We’re here to answer any questions you have about buying or selling a home. Just give us a call at 949-392-6400 – we will talk to you soon!