Debt to income ratio (DTI) is one of the important factors that can determine whether or not a lender will approve you for a loan. They use this ratio to determine your creditworthiness and whether or not you are a good risk for repaying the loan or credit to make purchases. You have to report all of your income, but income for which you don’t have documentation, such as getting paid for writing through Paypal, this income cannot be included in the ratio. Lenders also like to see income from the same source for at least two years because this shows that you are constant in your work and not hopping from one job to another.
When calculating your debt to income ration, lenders look at it in two ways. They calculate how much of your income goes toward paying your housing costs, such as in rent or paying a mortgage, insurance, principal payments and taxes. The other method of calculating the DTI is to include all of your monthly payments. This latter calculation is the one most lenders use. This is why some borrowers are confused when they apply for a mortgage and the lender does not take the amount of rent they are currently paying into consideration when deciding whether or not to approve the loan application.
To calculate your debt to income ration, add up all your income. For a couple with both partners working, this involves adding up the total household income. If you are divorced and receive alimony, you have to include these payments as income. If you work at a job where your income varies, take an average of the income over the past two years to arrive at a monthly income. Now add up the total of all your monthly payments. This includes rent because it is a payment that you make on a monthly basis. If you usually pay more than the minimum payment on your credit cards each month, only use the minimum amounts required for this calculation.
Divide the amount of the payments that you have to make each month by the total amount of your income. The answer is your debt to income ratio. The lower this score is the better for you when it comes to borrowing money or applying for a credit card. A score of 0.36 is really high and should alert you to the fact that you are in financial difficulty and possibly spending beyond your means. This type of high score also means you do not qualify for lower interest rates on loans and are likely paying the highest rates. It should be a sign to you that you need to take action on lowering your debts thus increasing your borrowing power.