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Debt-to-income ratio – why you should care
If you’re not a property owner or have no interest in getting on the property ladder, this article may not be for you.
However, if you want to become a homeowner one day, you’ll want to familiarise yourself with the content of today’s article.
Your debt-to-income ratio (DTI) is an important term to understand when considering purchasing a home. Your DTI can make it easier or harder for you to qualify for a mortgage, so knowing your DTI can help you better understand how easy, or difficult it’ll be for you to get on the property ladder.
Put simply, your DTI compares how much of your monthly income goes towards debt, including housing costs, personal loans and credit card payments, versus your monthly gross income. It gives lenders an idea of how much money you have to put toward your mortgage and the amount of debt you can handle.
For example, if your mortgage is £1,400 a month, you have a car loan for £200 and your credit card debt and other loans equal £400, your total monthly debt payment is £2,000 (£1,400 + £200 + £400 = £2,000). If your gross monthly income is £6,000, then your debt-to-income ratio is 33% (£2,000 is 33% of £6,000).
What is considered a good debt-to-income ratio?
The lower your DTI, the better. A DTI below 36% is preferable and will help you secure a better rate on your new mortgage because you’ll be perceived as a low-risk borrower able to manage their debts well.
However, as long as your DTI is below 43%, you should still be able to secure a mortgage, providing there are no other weaknesses in your application, such as a bad credit rating or too many credit applications in recent months.
If your DTI is above 50%, lenders may be concerned about your ability to manage multiple repayments and will therefore approach your application cautiously.
How to lower your debt-to-income ratio
If you’ve calculated your DTI and it’s close to or above the 36% optimal DTI, don’t be alarmed; there are things you can do to reduce that percentage.
It won’t happen overnight, but it is absolutely possible with consistent effort over time. Here are a few things you can do to lower your DTI:
- Increase the amount you pay monthly toward your debt. In the short-term, you may see your DTI increase, however in the long-term it will go down. Also, these extra payments will help lower your overall debt faster and save you money on interest payments.
- Keep track of your DTI monthly; this helps you see your progress, and watching your DTI fall month-on-month can help you stay motivated to keep paying down your debts.
- Avoid any unnecessary new debt. If you’re trying to reduce your DTI, taking on new debt will not help. If you were planning on making big purchases on credit, pause until you’ve secured your new mortgage.
- Alternatively, you could extend the duration of your loans. Doing this will reduce your monthly loan payments on the debt. However, it’s important to note that doing this may mean paying a higher interest rate to compensate.
- Addressing your debt is one way to improve your DTI; the other thing to consider is increasing your income. You can do this by securing a higher-paying role or starting a side hustle.
Photo by Johnson Johnson on Unsplash
