What is the debt-to-income ratio, and how to calculate it?
The debt-to-income (DTI) ratio is the percentage of your net monthly income that goes to paying your monthly loan payments. Financial institutions use it to determine your borrowing risk. A low DTI ratio indicates sufficient income relative to debt servicing, making a borrower more attractive.
The DTI ratio is an excellent indicator for evaluating your financial situation and current financial obligations. Also, this indicator should help you assess whether a new loan will cause an excessive financial burden on your monthly budget. For example, if your DTI is 20%, it means that fifth of your monthly income is spent on your credit obligations, but if your DTI is 50%, it means that already half of your net income is spent on loan payments.
Typically, borrowers with low debt-to-income ratios will likely manage their monthly debt payments effectively. Financial institutions usually want to see low DTI ratios before issuing loans to ensure that borrowers aren’t overextended.
The DTI threshold is often set by law and can vary in different countries, but it can also be determined internally by the financial institution. Although a person’s financial situation should always be assessed separately, there is an opinion among experts that a healthy DTI ratio does not exceed 50%.
Add up all your loan liabilities like a car loan, mortgage loan, student loan, etc.
Divide the total obligations by your monthly net income, and you will get a percentage that is your DTI.
Maya is looking for a car loan of 20 000 USD. She has a salary of 1 000 USD after taxes and is spending each month 400 USD on a mortgage loan and 50 USD on a student loan. The total monthly obligations add up to 450 USD.
Her DTI is calculated by adding up (400+50) and dividing it by 1000. Her current DTI is 450/1000=45%.
Most financial institutions might consider this ratio high since if she gets a loan of 20 000 USD with a monthly payment of 290 USD, her DTI will become even more significant (450+290)/1000=74%.
If your DTI is already high and close to or above 50%, you should consider reducing your monthly commitments or finding a way to increase your regular income. If you have extra funds, you might consider closing credit or reducing the total amount of an active loan sooner, thus reducing your monthly commitment. Or you could search for options to reduce your housing or regular utility costs by saving some resources (electricity, water, heat) or choosing a cheaper apartment or car.
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