Debt to Income Ratio: Unraveling the Enigma

debt to income

Are you contemplating a mortgage application? A lighter financial burden increases the likelihood of making mortgage payments on time. The mysterious yet crucial figure known as your debt-to-income ratio holds the key. This number reflects the proportion of your monthly earnings swallowed by debts such as credit cards, student loans, and auto loans.

So, what exactly is the debt-to-income ratio?

Essentially, it’s a yardstick that gauges the portion of your pre-tax monthly income consumed by your debts. A lower ratio is advantageous when applying for a mortgage.

Gross monthly income is the sum you earn monthly before taxes and other deductions. On the other hand, monthly debts encompass payments made each month to clear any outstanding debt. These could include auto, personal, or student loans and the minimum payments due on your credit card balances.

Crunching the numbers: How to determine your debt-to-income ratio

To calculate this elusive figure, divide your monthly debts by your gross monthly income.

Imagine your gross monthly income is $6,000, and your monthly debts amount to $2,000. This figure may encompass required payments for student, personal or auto loans and minimum credit card payments.

Dividing $2,000 by $6,000 results in approximately 0.33. Converted to a percentage, your debt-to-income ratio stands at 33%.

As your gross monthly income and monthly debts fluctuate, so will your debt-to-income ratio. For instance, if your gross monthly income climbs to $7,000 while your monthly obligations remain unchanged at $2,000, your ratio dips to around 29%.

What’s the ideal debt-to-income ratio?

Mortgage lenders differ, but most prefer that your total monthly debts, including projected mortgage payments, not exceed 43% of your gross monthly income. Keeping your ratio at or below this level makes you a more appealing borrower.

That said, securing a mortgage with a higher debt-to-income ratio is still possible. However, it may come with a higher interest rate, resulting in heftier monthly payments.

Suppose your debt-to-income ratio concerns you; fret not. You can improve it by decreasing your monthly debt by paying off debts or reducing credit card balances. Boosting your gross monthly income is another option. Both strategies can help lower your debt-to-income ratio.

What else piques lenders’ interest?

The debt-to-income ratio is just one element of the mortgage approval process. Lenders will also scrutinize your three-digit FICO credit score, which indicates your credit management prowess. A higher score is preferable, with a FICO score of 800 or more considered excellent. A high FICO score can mitigate the impact of a higher debt-to-income ratio in a lender’s eyes.

Additionally, lenders assess your employment history and savings. The better your overall financial well-being, the less likely a higher debt-to-income ratio will jeopardize your mortgage application.