Do you need to put your family finances in order? Maybe you need to get your family budget back on track? Or you need to apply for a housing loan? You need to understand some financial computations more than just income and expenses. There is such a thing as debt-to-income ratio and together, let’s try to understand it and how it can help us plot our budget.

• Related: How to Save Money | Ideas for a Two-Income Household

What is the Debt-to-Income Ratio?

The debt-to-income ratio, or DTI, is a comparison of an individual’s monthly debt payment based on their monthly gross income.

Meanwhile, gross income means the money you earn before taking out the taxes and other deductions.

There are a lot of misconceptions about DTI ratio, as featured by
Fannie Mae. Here are a few things to enlighten you on what debt-to-
income ratio is all about.

A 43% DTI ratio is typically the highest a borrower can have and still
get qualified for a mortgage. But most lenders prefer a 36% debt-
to-income ratio or lower, with no more than 28% of that debt going
towards mortgage or rent payment.

The Significance of the 28%

Why is there a need for 28% or less of the total debt to go towards a mortgage or rental?

That is because housing cost or rental cost is the major payment every household must settle each month. Lenders see to it that a potential borrower can manage the current debt load while paying their rent
on time.

A low DTI ratio makes a borrower more attractive as it indicates
that the borrower has sufficient income relative to debt servicing. It also demonstrates a good balance between debt and income.

High DTI Ratio Makes You Unattractive to Lenders

The bottom line is that the debt-to-income ratio determines how “attractive” you are towards lenders. That is how their measure your “creditworthiness.”

So, a high DTI ratio shows that an individual has too much debt for the amount of income he earns each month.

Lenders, especially mortgage lenders, use these metrics to measure an individual’s ability to manage monthly payments and repay debts.

Before qualifying for a loan, the banks, credit providers or lenders have to see first that the borrower can manage the monthly debt payments effectively. That one proof is a low DTI ratio.

Know More About Your DTI Ratio

Knowing your DTI ratio is very helpful when planning to arrange a mortgage, like when you are buying a home. Before you apply for the loan, knowing your debt-to-income ratio will save you time and effort and maybe money.

• Read: How to Prepare Your Kids for the New Normal

Here’s a handy DTI Ratio Calculator that you can use before talking to a lender for a loan. Use this to see how much your monthly mortgage will be and if you would be qualified for it. Remember, you have to get a 43% or lower DTI ratio to make sure your lender will approve your loan application.

How to Compute Your DTI Ratio

This calculator shows your front-end and back-end debt ratio. The front-end debt-to-income ratio calculates how much of your gross income is going toward housing costs. It is typically calculated as housing expenses, such as mortgage payments, mortgage insurance, etc.

• Related: Should You Default on a Personal Loan During the Pandemic?

Back-end DTI includes all your minimum required monthly debts in addition to housing-related expenses. It includes debts like credit cards, student loans, auto loans, and personal loans.

What Figures Do You Need?

Some of the figures you have to provide in the calculator are:

• your monthly gross income
• your spouse’s income after taxes,
• other monthly income from businesses or side hustles.

For the frontend expenses; these include:

• the monthly mortgage payment – include if you are paying more than one
  monthly mortgage
• annual property taxes
• annual homeowner’s insurance
• monthly HOA dues

For the back-end expenses, you have to provide all the debts, loans, and other monthly payments that are not related to the mortgage.

The calculator automatically computes the front-end ratio by
dividing monthly home expenses by the total monthly income
times 100 to get the rate.

Meanwhile, the backend ratio is obtained by dividing the monthly housing and debt payments by the total monthly income multiplied by 100.

How Important This Is

All these may sound tedious at first. But this figure is very important. Just follow the procedure and input the necessary data. You will get there.

Good luck!