Balancing your debt to income ratio and ways to manage your budget effectively
Whether you have applied for a new home mortgage, a bridging finance loan or another type of loan, you may have been told recently that your debt to income (DTI) ratio is high. If your DTI ratio is too high, you may not qualify for financing. Another alternative is that the loan amount you qualify for may be reduced. Your debt to income ratio is a ratio that lenders use to analyze your financial health and their risk of lending to you. Learning that it may be too high is a sign that you need to take steps to reduce debts and to manage your budget more effectively.
The DTI Ratio Calculation
Two different debt to income ratios can be singled out. The first ratio involves expenses that are related to your home only. If you wish to calculate this DTI ratio, all of home expenses should be factored in – taxes on the home, your homeowner’s insurance premium, as well as your monthly housing payment. The next step is dividing this figure by your gross monthly income. As for the second ratio, it analyzes your total debt amount. Auto loan payments, student loan payments, the minimum required credit card payments and all of the house-related monthly expenses mentioned above are to be added up. The final figure should also be divided by your gross monthly income.
Acceptable Ratios
Each lender has a different acceptable limit that these ratios must meet in order to qualify for financing. Limits for a conventional mortgage loan are generally 28 percent for the housing-only ratio and 36 percent for the total debt ratio. Talk to your lender about the ratios you need to quality for in order to meet your current financing requirements.
Improving Ratios
As you can see, your DTI ratio is an analysis of your debts compared to your gross income. Improving these ratios involves either lowering your required debt payments, increasing your gross income or both. While taking a second job is one option to consider, most people may find it easier to improve their debt ratio by reducing their required debt payments.
Strategies for Reducing Your Debt Payments
If your DTI ratio is too high, this may be a sign that you are trying to purchase a more expensive house than is affordable to you. You may consider making a larger down payment or restructuring loan terms to reduce the mortgage payment. For instance, you can buy down your interest rate or consider a longer loan term to reduce your monthly housing expense. Also consider ways to reduce your other monthly non-housing debt payments. If a car loan is close to being paid off, taking a few thousand dollars from a savings account and paying the debt off entirely is one option. Credit card payments are lowered as your balances decrease, so you can also pay down credit card debts in order to bring monthly debt payments down.
Managing Debts for the Future
Many people with a high DTI ratio are able to pay their monthly debt requirements without issue. Their payments are made on time each month without a struggle. However, the debt ratio is used by a lender to determine their risk level associated with lending to you. If your ratio is high or close to being too high, this is a warning sign that your debts are close to becoming unmanageable. Effort should be made now and in the coming months to reduce total outstanding debt balances owed. Calculate your own DTI ratio periodically to monitor your own financial risk associated with debts. While your debt to income ratio is an analysis of your loans and credit card debt, other expenses can be reduced to improve your financial health. Consider shopping for lower insurance rates, switching to a more affordable cable plan and other cost-saving strategies. Saving money in these areas may help you to reduce your other debts more effectively.
When you learn that the lender’s calculation for a DTI ratio is too high, this is a warning sign that your budget has grown too heavy with debts. You can take steps today to improve your DTI ratio and better manage your budget. These steps can help prevent your debts from growing out-of-hand.
about the author
Jacob Pettit is a financial advisor specialising in second mortgage. He is also a father who loves to spend time with his family. When he is not involved in doing business he likes to take his wife and children camping. He writes articles on various interesting topics related to finance, especially bridging finance.