Here's the Ideal Debt to Income Ratio
Are you planning to purchase a property? Knowing your debt-to-income ratio will help you determine if you are in a good position to borrow. It is a calculation performed by financial institutions to assess your level of debt. By calculating it yourself, you will be able to determine if you are living beyond your means and if you need to change your spending habits to get the financing required for your project. Debt management is important to reaching a low DTI threshold.
What is Debt to Income Ratio?
The debt-to-income ratio, or debt-to-income ratio, is a percentage obtained by a calculation that compares the amount of your debt to that of your gross income. It helps determine how much you owe for every dollar you earn. The lower your debt-to-income ratio, the more reasonable your debt level, and therefore the better your repayment capacity. This indicator allows you to estimate your ability to continue paying down debt and expenses, in addition to paying off a future mortgage.
The bank will therefore take this result into account in order to ensure that your new financing respects your repayment capacity. The debt-to-income ratio measures the debt ratio. It is calculated systematically by financial institutions, before granting a loan, to curb the risk of over-indebtedness. Indeed, an individual, a company, or a State cannot go into debt beyond a certain amount, to remain able to honor its repayments. For example, an individual cannot get into debt beyond 30% of his income. The debt/income ratio measures the current indebtedness of an economic agent, therefore its potential debt margin. This ratio is calculated by adding all debts divided by all income.
What Is the Ideal Debt To Income Ratio
Does your debt-to-income ratio exceed 50%?
This may be a sign that you are living beyond your means. Increasing your income is one way to improve your debt-to-income ratio towards buying a home. Going for an additional source of income would also allow you to pay off your debts more quickly. The cycle of over-indebtedness begins with people who are approaching the limits of these ratios. If you think you are in financial trouble and need help, you can take back control of your financial situation.
Knowing the “acceptable” debt limits will allow you to stay away from critical thresholds and avoid finding yourself on the brink. After purchasing the coveted property, will you still be able to travel, indulge in your hobbies, and continue to save?
What does a Low DTI Mean?
It is better to have a lower DTI. A lower DTI percentage tells the lender that your debt is low enough to award you a loan, approve a rental application or acquire a mortgage. It means you have a healthy financial status.
Typically, your DTI should be no more than 36% or lower. Anything between 37% and 42% is manageable, but if it is 43% or anything higher, lenders will see this as a red flag and this may considerably affect any chance you had of being a qualifying borrower or applicant. The ideal DTI should be any figure falling below 36%. This might have slight variations since every lender has its own threshold.
The ideal debt to income ratio of renting would be anything lower than 36%
For loans, the DTI should be anything lower than 36% with 28% of that being a rental payment or serviced mortgage
For mortgages, the same is true as is for the loan. The DTI should be anything 36% and lower. 28% of that figure should be for a rental payment
How Do You Calculate It?
The math to determine your debt-to-income ratio is simple, and it is a good idea to know your ratio before you apply for a mortgage. The first step is to total your monthly payments and then divide this by the total income you receive each month. Multiply the result by one hundred to get a percentage. If you don't want to do the calculations yourself, there are a number of calculation tools to help you out.
The debt-to-income ratio can be calculated using two formulas:
Gross Debt Amortization
This indicator is the percentage of your gross income that is spent on housing costs for the desired property. Typically, this should be between 32% and 39% for a loan to be made, but your financial institution may require a lower ratio.
Here's how to calculate it:
- Add up the monthly occupancy fees: mortgage payment + municipal taxes + school taxes + electricity and heating costs + 50% of co-ownership fees (if applicable)
- Multiply the amount obtained by 100
- Divide this new amount by your gross monthly income
Total Debt Repayment
This is the percentage of your gross monthly income that is spent on housing costs for the coveted property, in addition to your other debts. This should not exceed 44%, but a lender could also require a lower ratio. Generally, if this is less than 40% is considered adequate for obtaining financing.
Here's how to calculate it:
- Add up the monthly occupancy fees: mortgage payment + municipal taxes + school taxes + electricity and heating costs + 50% of co-ownership fees (if applicable)
- Add to this amount your other monthly financial commitments: loans, usually 3% of the limit on each of your credit cards and lines of credit (whether you have a balance or not), and child support, and any other payment for debt repayment
- Multiply the amount obtained by 100
- Divide this new amount by your gross monthly income
The costs of food and services, such as mobile phones, the Internet, or cable television, are not included in this calculation, since these expenses do not generate debt. As a general rule, experts agree that this calculation provides a more comprehensive picture of your situation since it takes into account all your current expenses.
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Why Do You Need To Know It?
This ratio is a general indicator used to assess how and if you can repay a new debt. If yours is too high, your risk is being refused a loan. However, depending on your financial situation, you could still qualify. Your financial institution will examine your file to assess your situation and your profile as a whole, taking several elements into consideration, including the following:
What is your type of income?
What is your field of employment?
How long have you worked at the same location?
What is the objective of your funding request?
What are your assets and liquidity?
How is your credit report?
A lender may also ask you to find a co-borrower or endorser to reduce the risk associated with your loan. The maximum ratios not to be exceeded to obtain a loan are critical thresholds. These are indicators of high debt. Getting close to them is dangerous, and passing them even more so. You would then be in a precarious situation in the event of the unforeseen, for example in the event of an unexpected interest rate hike, loss of employment, or illness.
Conclusion
With a good debt-to-income ratio, you put the odds on your side to get a loan, but also to make your mortgage, loan, and rental payments and meet your other obligations and new expenses related to the purchase of your home. If you want to know more about DTI and how you can lower yours, then we invite you to visit the Goalry Platform and go directly to the Debtry store.