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Debt-to-Income Ratio

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Your debt-to-income ratio is a widely accepted way of measuring how deep into debt you are. Many lenders use it as a factor in the pre-approval process of getting a loan. The ratio compares the amount of income coming in to the types and amount of debt you have.

The Two Sides

  • The front ratio compares your income to your monthly housing costs (this would simply be rent, or includes all the costs associated with your mortgage: property taxes, hazard insurance, and homeowner's association dues, etc.).
  • The back ratio includes the costs of the front ratio, plus all other recurring debt (credit cards, personal loan payments, car payments, student loan payments, alimony, child support, etc.)
Your DTI is then represented by front ratio (f) over back ratio (b): f/b.

How It's Calculated

DTI is based on gross household monthly income and monthly debt payments. The first thing you have to do is divide your yearly income by twelve. For example, if your yearly income is $33,000 dollars, your monthly income (33,000/12) is $2,750.

Say your monthly housing costs total $500 (you rent an apartment). Your front ratio (500/2,750) is expressed as a percentage.

500/2,750 = .18 = 18

The back ratio follows the same rules. Combine your housing costs ($500) with all your other recurring debt. These are monthly fixed expenses, that is, ones that will not be paid off in a few months. For example, if you have school loan ($210), credit card ($43), and car ($189) payments:

210+43+189+500 = 942

942/2,750 = .34 = 34

DTI = 18/34

What Does It Mean?

The back ratio is probably the most important and commonly utilized part of your DTI, but the two together may have a bearing on certain types of financing and loans. Generally, 28/36 is the limit for conventional financing. Anything higher than that makes you a high-risk borrower. 36 as a back ratio is more or less considered high debt, but, depending on whom you talk to, anything above 20 could be considered high or nearing dangerous territory. You can still get loans with a back ratio of over 36, but they would probably have to be through a government program of some kind.

If you are wondering if you should consolidate your debt, your debt-to-income ratio can tell you a little bit about your current financial standing. It can also tell you the likelihood of your being able to acquire a second mortgage, home equity line of credit, personal loan, or other method of consolidation. Staying aware of your debt-to-income ratio can warn you against future financial trouble, so keep an eye on it!

Patrick Hanan  Posted by Patrick Hanan on June 15, 2010

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