Understanding the Debt-to-Income Ratio

Understanding the Debt-to-Income Ratio

The debt-to-income ratio, or DTI, is used to measure a person’s debts against their income. This figure is used by most lenders and mortgage brokers in Toronto and across Canada to figure out if a person is qualified for a loan, or if they are, what kind of interest they might face because of their DTI.

Where the DTI is concerned, recurring monthly debts are what is factored into the equation. This applies to whatever debts that a person pays on a monthly basis. For instance, if a person pays $2,000 per month toward their monthly recurring debts but they make $6,000 per month, their DTI would be configured by dividing 6,000 by 2,000. That is 1/3rd, or approximately 33%. This is a good figure, as most lenders prefer to borrow to those with less than a 36% debt-to-income ratio.

What Entails a Good Debt-to-Income Ratio?

Everybody has a debt-to-income ratio, as long as they pay monthly  on any debts and make a relatively stable monthly income. However, it takes a fairly low DTI figure  to be approved for a mortgage by most lenders. They prefer to see a percentage of under 36%, with 28% or less of that number being appropriated toward the mortgage.

If this sounds pretty harsh given your current circumstances, you should breathe easily in knowing that it’s not impossible to reduce your debt-to-income ratio. It takes smart planning, determination and being completely on-time with all payments that you owe each month, but it can be done.

Getting a Healthy DTI

There are essentially only two ways to reduce your debt-to-income ratio: make more income, or pay less debts.

It’s often easier to reduce one’s debts than it is to increase one’s income, so let’s start there. You obviously cannot shirk your payments of your debts to improve your DTI, So it is often advisable to wait to pursue a mortgage, loan or line of credit until a larger debt in your life has been eliminated. This would include, for instance, paying off a car or getting completely caught up on bills that have accumulated interest or previous months’ balances. If you have to make less monthly payments toward your debts, your DTI figure will be vastly improved.

Now, let’s look at our example from earlier. If a person makes $6,000 in monthly income and pays $2,000 toward their recurring monthly debts, their DTI is 33%. This is, in itself, a healthier number, but it could be lower. If the same person were to make $8,000 per month while still only having $2,000 a month in debts, their DTI drops down to 25%. This lower percentage means that the person in question will have an easier time getting the loan or credit line that they want.

Debt-to-income figures play an important role in calculating how much credit a person can qualify for, or what the interest rate on their loan will be. It also factors into mortgage loan pre-approval, which determines how high of a loan a lender is willing to offer with your current DTI percentage.

 

Categories: Debt

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