When you’re in need of financial solutions, like home equity loans, HELOCs, or bridge loans, there are several factors that lenders take into consideration when deciding whether or not to qualify you and for how much. One of these factors you should have an understanding of is your debt-to-income ratio (DTI).
Besides your credit score, debt-to-income is one of the most important factors to develop an understanding of and to determine your potential loan. But what exactly is debt-to-income and how it is counted? DTI can be confusing since certain expenses are considered while others are not. So let’s break down DTI in more detail.
Your debt-to-income ratio is a way lenders measure your ability to manage monthly payments to repay the money you plan to borrow. There are two different types of DTI.
- Front End Ratio
- Back End Ratio
Front End covers your total housing expenses and obligations. Back end ratio covers your total housing expenses, plus all your monthly debt obligations.
Most lenders focus on the Back End Ratio. This is calculated by taking all your monthly debt payments and dividing that by your gross monthly income. Your gross monthly income is the amount of money you have earned for the month before taxes and deductions. If you pay $1,600 a month for your mortgage, $100 for your car loan, and then another $300 in remaining debts, then your monthly debt payments come to $2,000. If your gross monthly income is $5,000, then your debt-to-income ratio is 40%.
Understanding What Debts Go Into Debt-To-Income
When it comes to understanding and determining your debt-to-income, it can be tricky to distinguish what payments do and don’t count toward it. Typically, when calculating your DTI, you should take into account the following types of debt:
- Monthly mortgage payment
- Minimum credit card payments
- Auto, student, or personal loan payments
- Monthly alimony or child support payments
- Any other debt payments that show on your credit report
What’s a Good Debt-To-Income?
If you’re looking to access a loan, most lenders will be looking to see a Front End Ratio of no more than 28%. Back End Ratio of less than 43% to approve you, though some will go as high as 50% depending on your credit score, savings, assets, down payment, and the type of loan you’re looking for.
Understanding How to Lower Debt-To-Income
There are a few actions you can take if you are looking to lower your debt-to-income to qualify for a loan, such as:
- Create a budget/Track spending: When you reduce unnecessary purchases, you’ll be able to put more money toward paying down debt.
- Plan a way to pay off debt: There are two common ways to pay off debt. The snowball method is the first, which means you pay down small balances first while making payments on the other. Once the smallest has been paid off, you move to the next smallest in size and so on. The second is the avalanche method, which involves paying off the higher interest debts first. By choosing a plan and sticking to it, you’ll be able to lower your debts.
- Make your debt less expensive: Look into ways to lower the rates on your high-interest credit cards. This is typically easiest for those who have accounts in good standing and who pay their bills on time. Another option is to take out a personal loan, consolidating your debts into a loan with a low-interest rate and one monthly payment.
- Avoid new debts: Don’t make large purchases on your credit card or take on any new loans for large purchases. New loans can raise your DTI and lower your credit score. Avoid too many credit inquiries as well, as those can negatively affect your score.
The Alternative Solution
Understanding that a strict debt-to-income can deter many homeowners from qualifying for loans or reaching their financial goals can help lead you to success. Instead of dealing with life-changing and high-stress solutions, there is another path homeowners can take. Sale-leaseback programs offer solutions that allow homeowners to convert their equity into cash. How to get a loan with high debt-to-income ratio? You simply sell your house but stay there as a renter for as long as you need to. When you’re ready, you can repurchase your home or move to a new one. You’ll get the cash you need without the struggle of dealing with lenders or the stress of moving out when you’re not ready.
If you’re in need of financial solutions, it’s important to have an understanding of your debt-to-income ratio, what it means and how to improve yours. Talk to a financial expert about how you can get a better ratio and what other options are available to you.