Many people find it difficult to spend less than they earn.With so much laxity in the spending habit,it is no longer a long time debt would start to crawl into the life of such an individual.If adequate care is not taken,or the right tool used,and at the right time,huge debts,more than what the total asset of the person can face soon pile up.Emotional worries is a common problem of people in this condition.
As a rule,good management should the watchword of everybody.And it should be a lifetime commitment to prevent or curtail financial crisis.Along this line,one very good step in the right direction is to calculate your debt-to-income(DTI) ratio,a mortgage term obtained by dividing what you owe by what you earn,on a monthly basis.It is one of the easiest way to get a picture of your current financial standing.When you keep track of your DTI,you will be able to understand and manage your finances.Again,lenders will also use the ratio to evaluate you when considering your credit status.
How then can you calculate your DTI?The following information serves to shed more light on this process:
1.Basis of the calculation
DTI is usually calculated on the basis of a month.And why?One,perhaps because you have only a few things to add up in the process,as compared to if you have to add up payments over a period of one year.Two,using a basis of one month is reasonable as you can really picture your payments.It will be difficult to do this accurately for a year,most especially for those months ahead.
2.What to include or add-the parameters
Monthly debt payments are considered anything you can’t pay off in 4 to 6 months.So,in view of this,items such as utility bills,monthly food expenditure,home interior repair bill,water heater repair bill,and the like,should not be considered.These are usually a one- time expense.However,payments in respect of car,solar water heater,mortgage,and boat are done instalmentally in many cases,and should be included.
A lender in charge of your mortgage will prefer to do one of two things.If you are self-employed, your lender will use your net income in estimating your DTI.And if you are hired somewhere,the lender will use your gross income.Note also that each lender has different DTI
requirements.DTI is calculated based on your proposed monthly debt and not on your current monthly debt.
4.Types of DTI
Essentially,there are two types of DTI,namely,front-end DTI and back-end DTI.
The front-end DTI considers only your monthly housing- related expenses.There are differences in the demand of lenders in respect of front-end DTI limits,but a reasonable limit would be close to 30 percent.This means 30 percent of your monthly,before-tax income is going towards housing-related debts.Front-end DTI is usually lower than the back-end DTI.
In back-end DTI,all of your monthly debt payments are taken into account in the analysis.However,only the debts on your credit report counts,in addition to your home owner insurance,home owner’s associaton dues,and property taxes.Again,there are different requirements for back-end DTI limits,depending on the lender.Some lenders will allow up to 50 percent while others will require 40 percent or below.
5.Calculating your DTI
Whether you are calculating your front-end DTI or back-end DTI,the following example is a good guide(though real life figures will differ) to assist you in getting going :
Mortgage payment (including property taxes and insurance) or rent $200/mo
Home equity line of credit or loan payment $25/mo
Car payments $45/mo
Revolving credit payments (furniture, appliance loans, etc.) $65/mo
Student loan payments $50/mo
Minimum credit card payments times two $24
Other monthly loan amounts $51/mo
Child support payments $40/mo
Total monthly debt payments $500/mo
Net (take-home) pay $1500/mo
Bonuses and overtime $240/mo
Other income $60/mo
Alimony received $200/mo
Total monthly income $2000/mo
Total Monthly Debt Payments Divided by Total Monthly Income = Debt to Income Ratio
Understanding your DTI
The calculation shown above gave a DTI of 0.25 or 25 percent.This is an excellent result by any standard and is the type of DTI anyone would want to work towards each month.It shows that you are a good money manager and your income is well above your debt.You are creditworthy.All figures below 30 percent have this feature.
A DTI between 30 and 35 percent is just good.Eventhough you may not have problem with lending institutions,it is advisable to reorganize yourself and bring the value down to a point below 30 percent.
When you have a DTI between 35 and 40 percent,there are very few lenders that will turn their attention to your plight.Never mind,some will still manage to give you a loan.But watch it,as you may have to struggle each month to pay back.
Anybody having a DTI of 40 percent and above must watch it as lenders may not want to discuss the issue of any loan with you.The interpretation is that your credit level needs urgent attention.
Finally,calculating your debt-to-income is an excellent way to ascertain your level of creditworthiness.Lenders are up to use it to determine whether to offer you a mortgage or not.DTI is estimated as the ratio of the total monthly debt payment to the total monthly income.A value below 30 percent is an excellent card to display around.