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Debt-to-Income Ratio in Relation on How to Apply for a Loan
- Published: January 20, 2012 by Umma Queenan Comments (0)
When you Apply for a Loan, there is more to be concerned with than your credit score. So many people don’t realize that having a good credit score doesn’t always qualify them for a loan, and they just can’t understand why. They pay all their bills on time. They have never defaulted on a loan, there are no bankruptcies on their credit history, yet they were still refused that loan.
Although your credit score / history is a prime consideration of most lenders, it doesn’t always carry enough weight to get you that loan. There are other factors that also contribute to their decision such as your debt-to-income ratio, commonly referred to as a DTI.
In simple terms, a DTI is what portion of your gross income you spend on debts each month. If you have a very high DTI it signals the lender that you may not be able to handle yet another payment.
In order to understand what a lender is looking for, let’s take a look at how they come up with your DTI. A debt-to-income ratio is expressed as a set of numbers being notated as x/y. The first number ‘x’ is called your front ratio and the second number ‘y’ is called your back ratio.
The first number is what percentage of your gross income goes toward housing. This is the amount you spend for rent if you are a renter, and if you are a home owner it is your mortgage principal, interest, taxes and insurance.
In real estate or mortgage lending, it is referred to as PITI. The second number is all of your recurring debt, including the first amount, your housing debt. Conventional lenders generally look for a DTI of 28/36 or better. Federally subsidized mortgage loans can be slightly higher.
Now for an example, if your monthly income is $3,500 and your rent is $850. Your front ratio would be:
$850÷ $3500 = .24 or 24%
This is what we have so far, 24/y. Now we have to find your back ratio. Let’s say all of your debt each month, including utilities, credit card payments, automobile loan, insurance premiums and any other recurring debt totals to another $1,100.
To get the back ratio you would first add the housing cost plus the other recurring debt, and you would come up with $1,950 per month to cover all recurring debt. Then you follow the same formula to get your back ratio.
$1950 ÷ $3500 = .5571 etc. or 56%
Your DTI is expressed as 24/56. Your front ratio is just fine but your back ratio is way too high. While you may still qualify for a loan based on other variables, one of which is your credit score, you may pay higher rates for your loan than you would have if your DTI were lower.
The best way to remedy that is either to reduce your debt or to increase your income. With some solid financial planning, it can be done now that you know what you are looking for. Try to get these numbers within the acceptable range and you can probably qualify for a loan with decent rates.
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