Calculating Your Debt-to-Income Ratio in 2 Easy Steps
Have you ever sat down and calculated exactly how much money you spend each month on bills? If so, you are already halfway to calculating your DTI. In essence, your debt-to-income ratio is the amount of money you have left over after paying all your monthly expenses. But if you want a bank to fork over hundreds of thousands of dollars on loan to you, you have to get specific.
What Is Your DTI?
What the bank is trying to ascertain is whether you have enough money left over after paying all your debts each month to afford a mortgage payment; the lower your DTI ratio, the better your chances of getting a loan.
Your goal is to have a debt-to-income ratio that is lower than 35%. At 50%, most banks will turn you down because, for all intents and purposes, you are living paycheck to paycheck, and a mortgage payment would be too big of a financial risk to the bank. But at 35%, with debt taking up only around a third of your income, you have more than enough to cover the expense of a mortgage.
How to Calculate Your DTI
Debt is only half of the equation. The other half is how much income you bring in. That number is easy if you have only one source of income. You don't count bonuses or gifts or any other irregular income.
1. Use all sources of regular income that you receive every month. That includes your salary, retirement income, Social Security, dividends, etc.
2. Next, divide your total monthly payments or debt by your monthly income. So what kinds of expenses or debts do you include? These debts will include amounts that you owe based on a contract, such as your rent, car payment, credit card payments and student loans.
You don't, however, include expenses like electric, gas and other utilities that vary from month to month. You also don't include taxes in your DTI calculation, either for your expenses or for your income. Use your total gross income before taxes.
Ways to Improve Your DTI
If you find out that you have a DTI that is 50% or higher, you will have to spend some time eliminating some of your debt and/or increasing your income before you are ready to buy a house. To improve your DTI, try:
- Paying off debts.
- Paying down credit cards (closing accounts can hurt your DTI).
- Pay all bills on time for one year.
- Refinance your debt (reduce your interest rate).
There are many websites that offer their own debt-to-income ratio calculators. Here are a few from Bankrate, Money Under 30 and Finance Solutions:
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