Are you busy plowing through the multitude of advice available regarding what you should do to improve your chances of securing the mortgage that you need to buy your dream home? You’re probably finding plenty of information about your FICO credit score, why it matters, and how to improve it. However, your credit score isn’t the only number that lenders care about. Knowing how to calculate debt-to-income ratio and what it says about your financial health can help you make smart decisions that will put you in a better position when you’re ready to apply for a mortgage.
How to Calculate Debt-to-Income Ratio
Understanding how to calculate debt-to-income ratio, or DTI, is fairly simple. A few financial facts and a little math are all that’s necessary. Armed with this number, you will be ready to explore important questions like why DTI matters, what sort of DTI lenders are looking for, and how to lower your DTI.
As Investopedia explains, your DTI describes how your total debt compares to your gross income. Wondering how to calculate debt-to-income ratio? Start by totaling all your recurring monthly debts. This will include things like your housing payments, minimum credit card payments, auto loan payments, student loan payments, and child support and alimony payments. Then, compute your pretax income. This means adding up resources like your salary or wages, any tips or bonuses, pension payments, social security payments, and child support and alimony payments. Next, divide your total monthly debts by your total monthly income and multiply the resulting quotient by 100 to transform the answer into a percentage.
For example, if you have debts equaling $2,500 and a monthly income of $7,000, you would divide 2,500 by 7,000 to get 0.36. After multiplying 0.36 by 100, you would end up with a DTI of 36 percent.
Why Your Debt-to-Income Ratio Matters
Whether you’re looking to borrow or not, it’s handy to know what your DTI is. After all, it’s a helpful measure of your financial security. As SmartAsset explains, the higher your DTI is, the riskier your financial situation is. That’s why lenders are so interested in your DTI. A borrower with a higher DTI is more likely to struggle with payments or default on their loan than a borrower with a lower DTI.
Lenders and Debt-to-Income Ratios
As the Consumer Financial Protection Bureau reports, many lenders are unwilling to extend a home loan to a would-be borrower whose DTI is higher than 43 percent because that’s the threshold for securing a qualified mortgage. While it’s not impossible to get a home loan with a high DTI, you’re likely to pay more for the privilege. Basically, a lower DTI signals that you’re a better credit risk, so you’re more likely to secure a home loan with favorable terms if you have a low DTI. Lenders tend to prefer working with borrowers who have a DTI around 36 percent.
VA Loans and Debt-to-Income Ratios
What if you’re hoping to use a VA loan to fund your home purchase? Thanks to the guarantee offered by the U.S. Department of Veterans Affairs, these loans offer borrowers several significant advantages, including low interest rates, no down payment requirement, no mortgage insurance requirement, and more flexible qualification standards. However, borrowers using this program have to demonstrate that they have the financial means to qualify for the loan they are seeking, and DTI is a vital part of that process. According to VAntage Point, the VA’s official blog, borrowers generally need a DTI of 41 percent to secure a VA loan.
How to Lower Your Debt-to-Income Ratio
What can you do if you want to take advantage of a VA loan, but your DTI is too high for comfort? As Military.com notes, there are strategies that you can use to lower your DTI:
- Reduce your debt. Paying off loans ahead of schedule, targeting the bills that have the most impact on your DTI first, refinancing your debts to secure more favorable terms, and using balance transfers to decrease the impact of interest can all help you reduce your total monthly debt.
- Increase your income. To increase your income, you could seek out a higher-paying position, request a salary increase, work overtime, secure a second job, or use a hobby or skill to generate additional funds.
- Lower your housing payments. When you’re buying a home, lenders look at what your DTI will be with the new mortgage payment, so lowering your new housing costs can reduce your DTI. You could borrow less by negotiating a lower selling price or pay less each month by making a larger down payment. You could also find a more affordable home.
Now that you know how to calculate debt-to-income ratio as well as how to lower it, are you ready to start exploring your mortgage options?
With no lender fees and options for 100 percent financing, PrimeLending of Manhattan, Kansas, is ready to help you get the most out of your VA home loan benefits. We offer up to 100 percent financing, and we never require mortgage insurance. As an added bonus, we don’t charge lender fees. In fact, our expert loan team has helped countless borrowers save hundreds of dollars on their VA home loans, and we’d be delighted to assist you. Whether you want to buy a new home or finance your existing one, we can help you get the most benefit out of the VA home loan program. Contact us today to explore the possibilities.