How To Calculate Your Income
Calculate your monthly income by adding up income from all sources. Start with your base salary and add any additional returns you receive from investments or a side business, for example. If you receive a year-end bonus or quarterly commissions at work, be sure to add them up and divide by 12 before adding those amounts to your tally.
Don’t Forget Your Spouse!
Your spouse’s income is also included in your income calculation provided you are applying for the loan together.
What if Your Spouse Has Poor Credit?
If one spouse has poor credit and the other buyer would still qualify without including their spouse on the loan, then it can make sense to have the spouse with better credit apply for the mortgage individually. If the spouse with poor credit is included on a joint application the perceived credit risk will likely be higher. Bad credit mortgages charge higher interest rates.
Its Important To Have A Healthy Debt To Credit Ratio
Debt to credit ratio is one of the most critical factors used to determine your credit score. By using the formula provided in this article, you can quickly and easily calculate your credit utilization rate and use this information to adjust your spending practices as needed.
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What Is A Good Debt
The lower your DTI ratio, the more likely you will be able to afford a mortgage opening up more loan options. A DTI of 20% or below is considered excellent, while a DTI of 36% or less is considered ideal. Compare your debt-to-income ratio to our measurement standards below.
|36% or less
|DTI ratio is good
|A debt-to-income ratio of36/43 is favorable to lenders, because it shows you’re not overstretched. After paying your monthly bills, you most likely have money left over for saving or spending.
|37% – 50%
|DTI ratio is OK
|The maximum allowed DTIcan vary depending on the type of home loan you’re applying for and the requirements set by your lender. In most cases, the highest DTI that a homebuyer can have is 50%.
|51% or higher
|DTI ratio is high
|Just because you have a high DTI ratio doesn’t mean you can’t still qualify for a home loan. Lenders will look at your credit score, savings, assets, down payment and property value in addition to your DTI when considering your loan eligibility. Paying down debt or increasing your income can helpimprove your DTI ratio.
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Pay More Than The Minimum
Pay off your debt and save on interest by paying more than the minimum every month. The key is to make extra payments consistently so you can pay off your loan more quickly. Some lenders allow you to make an extra payment each month specifying that each extra payment goes toward the principal. Before you begin, check the terms of your loan to determine whether additional fees or prepayment penalties may apply.
Weigh Your Monthly Debt Payments Against Your Income To See If Youre Overextended
A debt-to-income ratio is a key factor that lenders use to determine if youll be approved for a loan. During the underwriting process after you apply for a loan, the underwriter will check your debt-to-income ratio to see if you can afford the loan payments. If your DTI is too high, you wont get approved for the loan.
For consumers, debt-to-income is an easy way to measure the overall health of your finances. You can check your DTI to see if you have too much debt for your income. If your debt ratio is too high, then you know to scale back and focus on debt repayment. If you need help, call to speak with a trained credit counsellor for a free debt and budget evaluation.
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Comparing Frontend Vs Backend Ratios
Now that you have your average monthly income you can use that to figure out your DTIs.
- Front end ratio is a DTI calculation that includes all housing costs As a rule of thumb, lenders are looking for a front ratio of 28 percent or less.
- Back end ratio looks at your non-mortgage debt percentage, and it should be less than 36 percent if you are seeking a loan or line of credit.
Understanding Your Financial Goals
Your DTI ratio is a valuable financial measurement that can help shine some light on your current financial situation. After all, we cant expect to make tangible financial goals if we dont have a grasp on where we currently stand.
Think about where you see yourself in a year, or even five years. Do you want to own a house? Or trade in your used car for a new one? If you have a specific financial goal in mind, its important to make plans that will help you achieve that goal.
For instance, if youre currently renting an apartment but youre interested in buying a house, you can use your DTI ratio to plan for the future.
First, calculate your current DTI. Afterward, the percentage you receive will not only allow you to understand your current financial situation but also make it easier to assess whether or not you need a different job, need to pay off some debts, or even how long it might take to save the money you need for a proper down payment.
Ultimately, no matter what your current circumstances may be, its never too late to start looking into aspects of your financial situation, such as your DTI ratio, in order to plan for the future.
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Income That Goes Into The Debt To Income Formula
The income that you will use for the debt-to-income ratio is your gross monthly income. This means your income before taxes are taken out.
If your pay varies monthly, divide your annual income by 12 for an average monthly income.
What Not to Include
Dont include other income like alimony or child support payments.
If Your Dti Is Between 3650%
It will be challenging to get approved for loans or financing if your DTI is within this rangeespecially for a mortgage or auto loan. Youll likely need a larger down payment or have greater cash reserves than someone with a lower DTI.
You may be able to quickly improve your DTI ratio by making extra payments towards a particular debt or increasing your monthly income, perhaps by taking on a part-time job. If you cant eliminate at least some of your debt effectively on your own, its time to explore debt relief. Less debt improves your debt ratio, as well as your credit score. Its a win-win.
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Shorten The Length Of Your Loan
Refinancing your debt to a shorter term may help you pay it off faster and save on the total cost of borrowing. You may be able to qualify for a lower rate, or a shorter or longer loan term, depending on your situation. Remember, shortening the term of your loan could increase your monthly payments.
How Much Does Your Debt
Your DTI never directly affects your or . may know your income but they dont include it in their calculations. Your is still factored into your home loan application. However, borrowers with a high DTI ratio may have a high credit utilization ratio which accounts for 30 percent of your credit score. Lowering your credit utilization ratio will help boost your credit score and lower your DTI ratio because you are paying down more debt.
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How Is The Debt
How To Lower Debt
Increase IncomeThis can be done through working overtime, taking on a second job, asking for a salary increase, or generating money from a hobby. If debt level stays the same, a higher income will result in a lower DTI. The other way to bring down the ratio is to lower the debt amount.
BudgetBy tracking spending through a budget, it is possible to find areas where expenses can be cut to reduce debt, whether it’s vacations, dining, or shopping. Most budgets also make it possible to track the amount of debt compared to income on a monthly basis, which can help budgeteers work towards the DTI goals they set for themselves. For more information about or to do calculations regarding a budget, please visit the Budget Calculator.
Make Debt More AffordableHigh-interest debts such as credit cards can possibly be lowered through refinancing. A good first step would be to call the credit card company and ask if they can lower the interest rate a borrower that always pays their bills on time with an account in good standing can sometimes be granted a lower rate. Another strategy would be to consolidating all high-interest debt into a loan with a lower interest rate. For more information about or to do calculations involving a credit card, please visit the . For more information about or to do calculations involving debt consolidation, please visit the Debt Consolidation Calculator.
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How Lenders View Your Debt
Now that you know how a debt-to-income ratio is calculated, you might be wondering what lenders think of your score.
The criteria can vary from lender to lender, but heres a general breakdown of the industry standards:
DTI less than 36%Lenders view a DTI under 36% as good, meaning they think you can manage your current debt payments and handle taking on an additional loan.
DTI between 3643%In this range, lenders get nervous that adding another loan payment to your plate might be challenging, especially if an emergency pops up. You wont necessarily get turned down for another loan, but lenders will proceed with caution.
DTI between 4350%When your DTI gets to this level, youre almost too risky for lenders, and you may not be able to get a loan.
DTI over 50%At this point, youre in the danger zone, and lenders probably wont lend you money. With a DTI ratio over 50%, that means over half of your monthly income is going to pay debt. Add in normal living expenses, like groceries and insurance, and theres not much left over for saving or covering an emergencyand another loan could tip you over the edge.
How To Improve Your Financial Profile
The number one rule of personal finance is to earn more money than you spend.
How Lenders View Risk
When you apply for a major loan, the lender won’t see how often you stay late at the office to help out the boss, what a great asset you are to your company, or how skilled you are in your chosen field.
What your lender will see when he looks at you is a financial risk and a potential liability to his business. He sees how much you earn and how much you owe, and he will boil it down to a number called your debt-to-income ratio.
If you know your debt-to-income ratio before you apply for a car loan or mortgage, you’re already ahead of the game. Knowing where you stand financially and how you’re viewed by bankers and other lenders lets you prepare yourself for the negotiations to come.
Use our convenient calculator to figure your ratio. This information can help you decide how much money you can afford to borrow for a house or a new car, and it will assist you with figuring out a suitable cash amount for your down payment.
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What Is A Credit Utilization Ratio
A credit utilization ratio compares the amount of money you owe to the amount of credit lenders are willing to lend you. Your credit utilization considers all balances and credit limits across all open revolving credit accounts, and on individual accounts as well.
This calculation considers the balance on your card when your statement closes each month, even if you pay your card off in full. In other words, it may not be enough to pay your card off in full each month to have a low credit utilizationâif you accrue a high balance that gets reported on your statement, this will impact your utilization even if you pay it off all in one payment.
We advise using no more than 30% of your credit limit, overall and on each individual card, in order to maintain healthy, attractive credit. Lenders will likely consider those who have too much credit utilization as higher-risk borrowers, so the lower your credit utilization, the better.
Note that only revolving credit, such as credit card accounts and home equity lines of credit, affect utilization. With these, you borrow and repay as you go. In contrast, installment credit like auto loans and mortgages involve borrowing a set amount and making a set monthly payment.
Example 4 Dscr + Fill Out Income Statement
In this example, we will calculate the Debt Service Coverage Ratio of Company D. Use the following information and the partial income statement:
The tax rate is 50%.
R& D Expense is $10M less than half of the firms SG& A Expense.
Principal Payments are double the Pre-Tax Profit.
Cost of Goods Sold is 60% of Sales.
Net Income is 25% of the Lease Payments.
SG& A Expense is 30% of the companys Sales.
Lease Payments are double the Interest Expense.
Step 1: Write out the formula
DSCR = Net Operating Income / Debt Service
Step 2: Fill out the income statement
To find the firms Net Operating Income, since most line items are blank, we must first fill out the income statement with the information we have:
Starting with the Interest Expense of $20M , we can figure out the Lease Payments since they are double the Interest Expense.
Lease Payments = 2 x $20M = $40M
We can now figure out the Net Income .
Net Income = 25% x $40M = $10M
Pre-Tax Profit & Tax Expense
The 50% tax rate implies that the tax expense is 50% of the Pre-Tax Profit. The firm keeps 50% of the Pre-Tax Profit as Net Income. Therefore, we can conclude that the Pre-Tax Profit is double the Net Income.
Pre-Tax Profit = 2 x $10M = $20M
Tax Expense = Pre-Tax Profit Net Income
Tax Expense = $20M $10M = $10M
Principal Payments are double the Pre-Tax Profit
Principal Payments = 2 x Pre-Tax Profit
Principal Payments = 2 x $20M = $40M
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What’s The Difference Between Your Debt
Debt-to-credit and DTI ratios are similar concepts however, it’s important not to confuse the two.
Your debt-to-credit ratio refers to the amount you owe across all revolving credit accounts compared to the amount of revolving credit available to you. Your debt-to-credit ratio may be one factor in calculating your credit scores, depending on the scoring model used. Other factors may include your payment history, the length of your credit history, how many credit accounts you’ve opened recently and the types of credit accounts you have.
Your DTI ratio refers to the total amount of debt you carry each month compared to your total monthly income. Your DTI ratio doesn’t directly impact your credit score, but it’s one factor lenders may consider when deciding whether to approve you for an additional credit account.
Familiarizing yourself with both ratios may give you a better understanding of your credit situation and help you anticipate how lenders may view you as you apply for credit.
Why Is Monitoring Your Debt
Calculating your debt-to-income ratio can help you avoid creeping indebtedness, or the gradual rising of debt. Impulse buying and routine use of credit cards for small, daily purchases can easily result in unmanageable debt. By monitoring your debt-to-income ratio, you can:
- Make sound decisions about buying on credit and taking out loans.
- See the clear benefits of making more than your minimum credit card payments.
- Avoid major credit problems.
- Jeopardize your ability to make major purchases, such as a car or a home.
- Keep you from getting the lowest available interest rates and best credit terms.
- Cause difficulty getting additional credit in case of emergencies.
Debt-to-income ratios are powerful indicators of creditworthiness and financial condition. Know your ratio and keep it low.
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Tips For Borrowing Money
- If youre thinking about borrowing money but arent sure how to make your credit work for you, consider working with a financial advisor. Finding a financial advisor doesnt have to be difficult. SmartAssets free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If youre ready to find an advisor who can help you achieve your financial goals, get started now.
- Credit cards come in all forms with different benefits and different costs. Consider using our tool to help you find the right credit card for your situation.