How To Calculate Your Debt-to-Income Ratio

Your debt-to-income ratio is your total monthly debt payments divided by your gross monthly income. Lenders will use a debt-to-income ratio to measure a potential or current borrowers ability to handle monthly payments to repay borrowed money.  If you apply for a loan modification, this is often one of the metrics by which the servicer of the loan will approve or deny your request. Calculating your debt-to-income ratio can help you see how your debt comes across to potential lenders before you apply for a loan. Here is everything you need to know about your debt-to-income ratio.

 

When calculating your debt-to-income ratio, add up all your monthly debt payments and divide them by your gross monthly income, or what you earn every month before taxes and other deductions are taken out. For example, the total debt for someone with a $1,000 mortgage, a $200 car payment, and $300 in other debts is $1,500 a month in debt payments. If this person brings in $5,000 a month before taxes, their debt-to-income ratio is 30% ($1,500 is 30% of $5,000).

 

For mortgages, there are two components lenders will look at when determining a DTI ratio: the front-end ratio and the back-end ration. The front-end ratio, also called the housing ratio, shows what percent your gross monthly income goes towards your housing expenses, including your mortgage payment, property taxes, homeowners insurance, and any HOA dues. The back-end ratio shows what portion of your monthly income is used to pay for your monthly debt payments, including mortgage and housing expenses as well as credit cards, car loans, child support, student loans, and any other debts. Most lenders typically agree that the ideal front-end ratio should be no more than 28% while the ideal back-end ratio should be 36% or lower.

 

So why is the debt-to-income ratio important? This ratio was essentially created to protect potential borrowers from predatory lenders and to ensure they do not bite off more debt than they can chew. There is evidence that borrowers with a higher debt-to-income ratio are more likely to have issues making regular monthly payments. Generally, lenders see consumers with a high DTI as risky borrowers. Because of this, 43% is the magic number for debt-to-income ratios. In accordance with the Consumer Financial Protection Bureau guidelines, 43% is the highest ratio a borrower can have and still receive a Qualified Mortgage.

 

There are some exceptions to this 43% rule. Small creditors—those with less than $2 billion in assets and who made no more than 500 mortgages in the previous year—can offer a Qualified Mortgage when your debt-to-income ratio is higher than 43%. Larger lenders may also be able to give you a mortgage loan if your ratio is higher than 43%, but they will need to prove they have made an effort to determine whether or not the borrower can actually pay back the loan.

 

If you need to lower your DTI ratio to get a loan or a loan modification, there are a few things you can do. Start by making a plan to pay down your debts as quickly as possible. Cut out unnecessary expenses and make a budget that emphasizes paying off your debt. You can also try to see if your lenders or credit card company will lower your interest rate. If your account is in good standing and you regularly pay your bills on time, you may be surprised at how willing your creditors are willing to work with you. Consolidating your debt by transferring high-interest balances to an existing or new account with a lower rate may also help you manage monthly payments. Most importantly, avoid taking on more debt until your DTI ratio is where you need it to be.

 

Figuring out your debt-to-income ration can be useful in determining how much debt you can handle. Veitengruber Law is a full service debt negotiation law firm. We can help you determine your DTI ratio and help you lower your ratio if needed. Whether you are looking to lower your ratio to buy a house, modify a mortgage payment, or simply get out from under your debt, Veitengruber Law can help.

Reduce Debt NOW Rather than Later and Save Thousands

The average American household is leveraged with $137,000 of debt. That’s a crushing number. No matter what your debt looks like, you can (and should) take steps now to eliminate years of payments – potentially saving you thousands of dollars. Following are four of the most common kinds of debt weighing Americans down, along with debt-reduction tips for each type of debt.

Mortgage:

A mortgage is one of the largest debts most people will take on in a lifetime. With a minimum down payment, you will pay thousands of dollars in mortgage insurance (PMI), which is basically wasted money. If you can’t put down 20% to avoid PMI, you should refinance as soon as your home value increases enough that your equity is the equivalent of 20% or more.

Pay attention to comparable home values in your neighborhood and refinance your mortgage as long as the interest rate is low. If you began with a 30-year mortgage, try to refinance to a shorter term. You will pay much less interest over the course of the loan. Choose a 20 or 15-year mortgage and spend your later years without a mortgage payment!

Another effective way to reduce mortgage debt is by making bi-weekly payments instead of monthly payments. This means you will make 13 payments per year instead of 12 and most people won’t even notice the difference.

If you are unable to pay your mortgage or are behind on payments, address it before it gets out of control and you lose your home.

Student Loans:

One of the worst kinds of debt is student loan debt. It will often survive even if you declare bankruptcy. Your wages can even be garnished if you fail to pay your student loans back. Look to consolidate your loans into a low interest rate. Refinancing federal loans with a lower interest private student loan lender is another great option. Veitengruber Law can help you reduce your student loan debts once we meet with you to discuss the specific details of your debt(s).

 

Medical:

Debt from medical bills is one of the “best” kinds of debt to have. You can often negotiate an interest-free payment plan with the provider. Be careful not to ignore these bills and let them go to collections, though. Having any kind of debt in collections can ruin your credit and prevent you from making future important purchases.

 

Credit Cards:

If your credit card debt is out of control, you need to stop adding to the problem and put away the cards. Don’t close the accounts – this will negatively impact your credit score. Put the cards in safe place where you won’t be tempted to use them, and start using a debit card or cash only.

Because the interest rates of most credit cards are so high, repaying significant credit card debt can take years. Always make more than the minimum payment so you are impacting the balance and accruing less interest.

If your credit score is still good, transfer your high-interest card balances to low or no interest introductory period credit cards with no balance transfer fees.*

*IMPORTANT NOTE: Read the fine print before you do this. Credit card companies are cracking down on consumers moving money from card to card to avoid paying interest. You could be hit with a very high rate at the end of the introductory period, or with retroactive interest fees if you move the debt a second time.

---

There are several strategies you can use to pay down your debt; read our blog post entitled “Snowball vs Avalanche: Digging Your Way Out of Debt” to find the strategy that works best for you and stick to it.

---

Allowing any type of debt to get out of control can have disastrous effects on your life. The stress of debt can lead to depression, anxiety, physical health problems, relationship problems and more. You may also find yourself in small claims court, civil suits, foreclosure proceedings and bankruptcy court. Your assets like televisions, computers, phones, and cars could be liquidated (sold) in order to pay your creditors.

Take steps now to gain control before your debt becomes an insurmountable mountain. Need help getting started? Call Veitengruber Law for a free consultation.