What is the debt-to-income ratio?

Good personal finance management requires that you learn some basic concepts to understand the factors that allow you to borrow. This is the case with the debt-to-income ratio (DTI), an almost mandatory requirement to obtain a mortgage loan and other kind of loans.

If you still don't know what it's all about, we tell you about it.

What does the debt-to-income ratio represent?

DTI is a metric that tells you the percentage of debt you are paying monthly with respect to your gross income (before taxes).

That is, when you add up the credit payments you make in 30 days and compare them to what you earn, you get the DTI.

What's the debt-to-income ratio?It is important to understand that the debt-to-income ratio only considers the minimum payment for the following categories: mortgage loans, auto loans, student loans, credit cards, personal loans and other debts reported to the bureaus. You can find this out by reviewing your credit report.

Let's assume for a moment that you have to spend about $500 a month to pay for different items (cards, loans, mortgage, etc.) and you earn $2,000.

The formula to make this calculation is very simple: just divide both figures (debt ÷ income) and then multiply by 100. In this example, your ratio would be 25%.

What is debt-to-income ratio for?

When it comes to smart personal finance management, you shouldn't overlook this figure. The reason: this percentage tells you how balanced your financial habits are.

When you have a high DTI, it means you are investing more in debt, leaving you with less capital at the end of the month. Conversely, a low DTI means you are managing your money better.

This is important because it has been shown that people with a debt-to-income ratio above 45% have trouble meeting their commitments.

This risky behavior is frowned upon by banks and lenders, who prefer to grant financing to those with low or average debt-to-income ratios.

Does the debt-to-income ratio affect your score?

Not really. Many people are under the impression that this data could negatively affect their score, which is not true.

This is explained by the fact that there are consumers who earn a lot of money and have a mediocre score, while there are others who earn very little and have an almost perfect score.

The credit score is based solely on your records related to credit instruments and the history of how you have managed your indebtedness.

DTI can indirectly influence your score because it leaves you with less liquidity each month, decreasing your ability to pay for other financial commitments.

Comparing debt-to-income and debt-to-limit ratios

When it comes to differentiating financial terms, we invite you to be clear about what each of these elements is.

We have already seen what the DTI is about, so we need to define the debt-to-limit ratio, also called credit utilization ratio, which refers to the percentage of credit you are using with respect to the total financing you have available.

It is a metric that estimates the debt balances you have each month in relation to the full amount of credit you currently have. In other words, it serves to find out if you are maxing out your credit cards.

DTI evaluation by banks and lenders

When you intend to apply for a personal loan, credit card or mortgage, financial institutions and companies will want to know your debt-to-income ratio.

This is because they want to reduce their risks when offering money, so they may require you to have a debt-to-income ratio of less than 45%, which is an industry standard.

It is recommended in this case to have a DTI below 36%, which usually makes it easier to get approved for larger loans. However, if you can be below 30%, that represents an ideal condition.

Remember that each lender has its own requirements on this data and it is not the only thing they evaluate.

Creditworthiness based on debt-to-income ratios

Creditworthy is undoubtedly one of the most relevant factors to obtain additional capital. That is why we give you 3 examples of what your debt-to-income ratio looks like:

  • Having a DTI of 50% or more means you have little money to spend or save. This limits your borrowing options and complicates your situation in the event of an unexpected event.
  • When you are between 36% and 49%, you are in a manageable zone that can be improved. You may be asked to meet other requirements to increase your eligibility.
  • If you are below 35%, you can manage your debt well and have money left over for other expenses, making you a near pre-approved candidate.

The debt-to-income ratio indicates trends in managing your personal finances. If you want to get more credit and make ends meet, Busconomico can help you achieve your goals.

Español: Qué es la proporción deuda-ingreso