Understanding Debt to Income Ratio

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Calculating and understanding your debt-to-income ratio doesn’t have to be a struggle.

If you’ve done research into applying for a VA home loan or car loan, you may be familiar with lenders calculating your debt to income ratio. It’s important to know how to get a general idea of what your debt-to-income ratio is, how it is calculated and why it may affect your future financial decisions.

What is a debt-to-income (DTI) ratio?

Debt-to-income ratios are exactly what they sound like — a comparison of your monthly debt to your monthly income.

What is included?

This is one of the most common questions about DTI ratios. Sometimes things we wouldn’t include in our monthly debts may show up in our DTI ratio and other things we expect are left out.

Possible Inclusions

  • Current mortgage payment
  • Car payment
  • Student loan debt
  • Minimum credit card payments
  • Child support payments (included in debt and income)
  • Childcare
  • Co-signed loans
  • Monthly income
  • Bonuses

Not Included

  • Utility payments
  • Insurance
  • Household expenses
Loans

Knowing about your DTI ratio is important when you want to apply for a loan.

Why is it important?

Your DTI ratio, like your credit score, is another way for lenders to determine your ability to pay back a loan. When your DTI ratio is high, your expenses are verging on overtaking your income and this means you’ll be less likely to pay back a loan.

Generally, the more you’re asking for, the lower your DTI will need to be. The VA benchmark is a 41 percent DTI ratio, which is higher than most other loan programs. Prospective homebuyers with a ratio above that threshold have to meet additional financial requirements.

What if it’s too high?

Cutting recurring debt or suddenly making more money are difficult propositions. But there’s another way to lower your DTI ratio when you’re looking to purchase a home: Shoot for a lower purchase price. Seeking a smaller loan amount will mean a smaller monthly mortgage payment, which in turn will lower your DTI ratio.

That can be a tough pill to swallow for some military buyers, but it can sometimes prove the simplest path to getting into a home.

Photos courtesy of Philip Taylor PT & Photosteve101