Your Debt-to-Income Ratio – What Is It and How Can It Affect You?
You might notice when you apply for a mortgage or car loan that your lender will ask for your debt-to-income ratio. This is a metric used to measure the amount of debt you have in relation to how much income you make. The higher the ratio, the more likely you are to default on your payments and the worse the effects may be on your credit score. Knowing how this ratio affects how lenders see you can help you manage your finances better so that you can use them responsibly.
Why should I care about my debt-to-income ratio?
A high debt-to-income ratio makes it harder for lenders to offer loans because they’re concerned that if something goes wrong and they end up having to foreclose on your home, they’ll also lose money. So if they owe more than what you make, then they’ll be out of luck.
What is a debt-to-income ratio?
The debt-to-income ratio is the amount of total debt you have in relation to your gross monthly income. Your mortgage company or car dealership will use this metric to gauge how much money you can afford to pay back each month. The higher the ratio, the more likely you are to default on your payments and the worse that may be on your credit score.
How does debt affect your credit score?
But it’s not just the lender who has to worry about your debt-to-income ratio. Your own credit score will be affected as well. A high debt-to-income ratio can lead to a lower credit score, which makes it more difficult for you to get loans or even find a new apartment.
So how do I calculate my debt-to-income ratio?
Your debt-to-income ratio is calculated by dividing the amount of money you owe by your gross monthly income. So if you make $2,500 a month, and your monthly debts are $1,000, then your debt-to-income ratio is 50%. The higher this number is, the riskier it appears to lenders and the lower your credit score becomes. To help keep your debt low and improve your credit rating, set up an emergency fund and pay off any high interest accounts like student loans first before trying to buy anything else.
What makes up the debt-to-income ratio?
The debt-to-income ratio is the amount of income you make, divided by your total monthly debt obligations. Income includes all sources of money like salaries and wages, as well as investment income. Total monthly debt obligations include all your debts like student loans, car loans, mortgages, and credit card bills.
How do lenders calculate my debt-to-income ratio?
Lenders use different formulas to calculate your debt-to-income ratio. Some might just look at your total monthly debt obligations while others will also add in a percentage of every unpaid bill that’s due within the next three months (this is called a front end ratio).
A loan officer may take more than one look at your application before making a decision to approve or deny you for a loan. The first time they look at it, they’ll be looking for things like whether or not you have any late payments on your account and how much of your available credit you’re using up. The second time around, they’ll compare what you make to what you owe to see if you can afford the payments for the new loan with other expenses that are due each month.
How do I calculate my debt-to-income ratio?
You can calculate your debt-to-income ratio by dividing your annual income by the total debt you have.
Annual Income: $65,000
Monthly Debt: $3,000
Debt/Income Ratio: 20%
The debt-to-income ratio is one of many factors used to determine whether or not you will be approved for a loan. Lenders consider other things as well when they are deciding if they want to give you a loan, such as your credit score or the type of home you are looking to purchase. But this metric is still a good indicator of how responsible you are with managing your debt and money.
Can I lower my debt-to-income ratio?
The best way to lower your debt-to-income ratio is by paying off your debts. As you pay off the loan, your debt ratio will go down. If you have a high debt-to-income ratio, then lenders may not be willing to give you loans because they’ll likely end up charging higher rates for the amount of risk that comes with lending to you.
Paying off your debts not only lowers your debt-to-income ratio but also makes it easier for you to make payments on time. If something goes wrong, then it won’t affect your credit score as much because there’s less outstanding debt attached to it.
Conclusion
A high debt-to-income ratio can make it difficult to qualify for a loan, an apartment, or even a job. But there are a few small changes you can make to lower your debt-to-income ratio and improve your chances of qualifying for a loan.
First, look for ways to reduce your monthly liability. Second, try to increase your income by finding a higher paying job or starting a side hustle. And third, look into what types of loans you qualify for.
It’s never too late to get on the right track and work towards a more financially stable future.
We here at Capital Mortgages look forward to assisting you with Ottawa mortgage needs and approvals. Contact us today by calling us at: 613-228-3888 or email us direct at: info@capitalmortgages.com
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