Credit 101: “Debt-to-Income”

What Exactly Is Debt To Income and Why Is It So Important?

The Debt-to-Income Ratio is perhaps one of the most mentioned yet least understood ratios in the topic of finance. It’s quite simple when you break it down in normal layman’s terms. Most lenders have parameters as to what the maximum amount of monthly payments a person may have in light of their income. To put it simply, if more than half of your monthly income is designated for loan payments, disaster is on the horizon. It may be a good time to put the brakes on using credit and time to start focusing on paying things off.

Most mortgage applicants for example may need to remain under 45% DTI whereas consumer loan lenders may allow up to 50% DTI. What this means for you, is that a consumer loan lender may want to make sure that after adding the loan you are applying for to your list of monthly obligations, that not more than half of your income be required for minimum payments. 

Debt-to-Income Calculation: 

[ (Total Monthly Minimum Payments / Gross Monthly Income) X 100 ] = DTI%

If max DTI is 50% then someone with $3200 per month in pretax income should not have more than $1,600 in minimum loan payments each month. 

Oftentimes lenders are only concerned with the debts that you owe that are showing up on your credit report, and not as much with what bills you may pay in addition to that (Credit cards payments and auto loan payments versus your phone bill or utility bill.) You can calculate your own debt-to-income easily buy first adding up your Gross Monthly Income and all of the minimum loan payments you are obligated to come up with each month. Take your Total Monthly Payments and divide them by your Total Monthly Income before taxes are taken out. The result should be in decimal format (i.e. 0.32 = 32%,  0.43 = 43%) 

Someone with a High DTI is in a high risk category for impending financial disaster. That is why this ratio is so frequently the topic of discussion when you are applying for a loan. A loan you have cosigned for another person to obtain will then be included in your own list of debts and thus may result in raising your own Debt-to-Income too high acquire a loan for yourself. This is usually the case for parents cosigning for multiple children. Mom and Dad have not only their home mortgage, credit cards, and auto loans, but also their daughter’s car loan and their son’s 4 wheeler loan. It can stack up quick and prevent Mom and Dad from getting the next thing. 

For strategies on getting free of debt CLICK HERE to read: “Debt Consolidation – Part 2”

Your Friendly Neighborhood Banker,

Josh Romine