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Calculating Your Debt to Income Ratio: What’s the Sweet Spot for Lenders?

Calculating Your Debt to Income Ratio: What's the Sweet Spot

Calculating Your Debt to Income Ratio: What’s the Sweet Spot for Lenders?

The Housing Affordability Index is something that experts use to determine if a family earns enough money to buy a house. You must make enough money to qualify for a loan, so this index is vital.

When you apply for a loan, you probably will not hear anything about this index, though. Instead, your lender might talk about numbers, amounts, and ratios, and they will likely bring up the debt to income ratio.

If you aren’t sure what the debt to income ratio is, you should learn before applying for a loan. This ratio helps lenders determine your risk level and loan amount, and all lenders use it.

Here is a guide to help you learn the definition of this ratio, what a good one is, and other information relating to debt to income ratios in lending.

The Definition of Debt to Income Ratio

Lenders use various tools and calculations when evaluating loan applications, and one of these is debt to income ratios. A debt to income ratio compares a person’s debt payments to their income to see where they stand.

The purpose of this calculation is to determine risk. People with high debt to income ratios might have trouble repaying loans, as they already have high debt loads. As a result, a bank will consider a person like this a high risk.

People with lower ratios might face fewer challenges in paying their loans. Banks view these individuals as low-risk borrowers.

Your debt to income ratio reveals a lot about your financial picture. Not only is this important to understand, but it is also essential to calculate your ratio before applying for a mortgage.

How to Calculate Your Debt to Income Ratio

Are you wondering how to calculate debt to income ratio? If so, here is an explanation to help you learn how to determine yours. To find your debt to income ratio, you must know two main things:

  1. Your gross monthly income
  2. Your total monthly debt payments

First, your gross monthly income is a total of all the income you earn per month. It is the amount you earn before taxes, and it should include income from all sources.

Next, your total monthly debt payments include routine debts you must pay each month. Your total debt payments might include your car payments, student loans, credit cards, and other loan payments.

You do not include your regular monthly expenses, such as utility payments and insurance. This ratio only factors in other types of expenses that are “extras.” In other words, you should add in any types of loans that you will eventually pay off.

Once you have these two amounts, you divide your gross monthly income by your total monthly expenses. The answer you get is a percentage, and this percentage is what matters to lenders.

If you have trouble calculating these amounts yourself, you could use a ratio simplifier, which is a tool that calculates the ratio for you. To use it, you input the amounts it asks for, and the tool provides your debt to income ratio.

What Lenders Look for With These Ratios

While lenders view factors other than your debt to income ratio, this ratio is one of the most important factors in a lender’s decision. What is a good debt to income ratio, you might wonder?

Most lenders view a ratio of 43% or less; however,  most lenders prefer a ratio of 36% or less. If your ratio is higher than 43%, you will probably face challenges getting approved for a loan.

This ratio reveals a lot about your risk level. When a person has few debts to pay each month, they may have an easier time paying their bills. People strapped with major debt loads, on the other hand, often face more challenges paying their bills.

Banks know this and fully understand how this works, which is why they place a lot of weight on a person’s debt to income ratio. If you’re worried that yours is too high, you might want to work on improving it before applying for a loan. 

Ways to Improve Yours Before Applying

So, what is the best way to improve your debt to income ratio? Well, there are several options you can pursue.

The main goal is to increase your income and decrease your debt payments. If you can achieve these goals, you can transform your ratio to meet the sweet spot that lenders look for when evaluating loan applications.

The first step is to find ways to increase your income. Is there a way you can work overtime at your current job to bring home more money? Could you take on a second job or start a home business to increase your income quickly.

Finding ways to increase your income will instantly help you improve your debt to income ratio. The next step, though, is finding ways to reduce your expenses.

The most logical way to decrease expenses is by paying off your loans. For example, if you have a car loan with a $500 monthly payment, is there any way you could pay off the balance of the loan? If so, you’ll see a positive change in your ratio.

Keep in mind; you shouldn’t use all your cash to pay off your loans, though. You must keep some for your down payment and moving expenses. If necessary, you might want to spend a few months working on paying off your debt before applying.

If you can pay off enough debt in a few months without using all your savings, you’ll see an improved financial position.

Make Sure You Prepare Financially Before Applying

As you can see, your debt to income ratio matters a lot when applying for a mortgage. Additionally, your credit score also matters, as does your financial picture.

If you feel like you’ve learned a lot about mortgage lending in this article, you might be ready to learn more. You can learn more by browsing through our website for lots of other articles.


Stress Over Debt?: How to Get Rid of Student Loan Debt

Stress Over Debt?: How to Get Rid of Student Loan

Stress Over Debt?: How to Get Rid of Student Loan Debt

Over half of young adults that went to college in 2018 took on debt. If you are one of the many people that have student debt, it can be very stressful to be under the weight of paying off thousands of dollars in debt from going to school.

We are here to help you see the light at the end of the tunnel. Continue reading this article to learn how to get rid of student loan debt.

Student Loan Repayment Assistance

One of the things that will become more popular is student loan repayment assistance programs. Many employers that are competing for top talent will offer these programs as a benefit to get people to come to work for their company. If you can find an employer that offers this as a benefit, you might be able to get a chunk of your loans repaid.

Enroll In Income-Driven Repayment

Do you feel like you’re drowning under the weight of the debt you owe for student loans? If you don’t feel like you can afford what you have to pay for your student loans, you can apply to lower your payments according to your income.

There are different types of repayment plans available depending on your situation, so make sure to check into every option.

Qualify for Federal Student Loan Forgiveness Programs

If your student loans are through the federal government, you might be able to qualify for federal student loan forgiveness programs. There are different programs, but one of the most popular programs is the Public Service Loan Forgiveness program. Under this program, if you work in public service for 10 years, your loans can be forgiven.

Consolidate Your Student Loan Debt

While consolidating your student loan debt isn’t going to make it go away, it can make it easier to manage. Instead of trying to figure out what you owe and when you owe it, you’ll be able to have one loan and can easily see the balance.

If you find that you miss payments a lot because you can’t keep track of your loans, this might be a good option for you.

Refinance Your Student Loans

If you have private student loans, instead of continuing to pay high-interest rates, you might be able to refinance your loan to get a better interest rate. If you can get a lower interest rate, your payment could be a lot lower, or you could continue to pay the bigger payment and pay off your loan a lot faster.

Make sure the new interest rate is low enough that it is worth the trouble of refinancing your student loans.

Now You Know How to Get Rid of Student Loan Debt 

Now you know how to get rid of student loan debt. With the information you have, you can start working toward your financial freedom from student loans.

Do you want to learn more about personal finance, education, and other important topics? Keep reading our blog to get the information you need.