Debt-to-Income Ratio: What Is It & How Can You Find Out Yours? | Refresh Financial
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Debt-to-Income Ratio: What Is It & How Can You Find Out Yours?

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There is no cryptic hidden meaning to the term debt-to-income ratio. It’s as straightforward as it sounds: how much of your income is spent on debt.

There are two different ways your debt-to-income ratio can be approached. The first takes into consideration the amount of your income that is spent on your housing situation, whether it be rent or mortgage. For instance, if your monthly income is $5000 and your mortgage payment is $1000 each month, that makes your ratio 20%. This first type of ratio is called your front end ratio, or mortgage-to-debt ratio.

If lenders want to expand the picture, they will take into consideration all of your other debt obligations, such as loans, credit card payments, line of credit payments, etc. Adding all of your debt together and calculating how much of your income goes towards it, is called your back end ratio.

Why You Need to Know it

Your debt-to-income ratio is definitely something you should know, especially if you’re looking to be considered by lenders for loans, mortgages or lines of credit. The magic number in Canada seems to hover around 40% - people with a back end debt-to-income ratio below this will have an easier time getting a mortgage, than people with a ratio above it. The idea here, is that a lower debt-to-income ratio indicates you’re living well within your means. It shows you are a financially responsible person, and that means lenders see you as low risk.

How to Calculate Your DTI

So, what is your debt-to-income ratio? To calculate your front end ratio use the following simple equation:

x ÷ y

Where x is your total monthly mortgage or rent payment and y is your gross monthly income. For example, if my gross monthly income is $4500 and my monthly mortgage payment is $1100, your calculation should look like this:

1100 ÷ 4500 = 0.24

Therefore, your front end debt-to-income ratio is 24%.

To calculate your back end ratio, try this calculation:

a ÷ y

Where a is your total debt payments each month, including your mortgage, and y is your gross monthly income. Using the same numbers above as an example, with $4500 in gross monthly income and $1100 monthly mortgage payment, but we add in a $70 credit card bill, a $200 car loan payment and $50 paying off a line of credit, your calculation should look like this:

1100 + 70 + 200 + 50 = 1420

So, $1420 is what you’re paying in debt each month and it should be the number that replaces ‘a’.

1420 ÷ 4500 = 0.32

Which means your back end debt-to-income ratio is 32%.

The standard debt-to-income ratio that lenders use to determine if you are low risk, is around 40%. You’re probably not going to be considered for a mortgage with a debt-to-income ratio higher than this. There are exceptions, though. If you have a larger than usual down payment to put on the home you hope to buy, this ratio may be reconsidered. You may also find smaller financial institutions, like local credit unions, may be a little bit more flexible.

How to Improve Your DTI

If you calculate your debt-to-income ratio and you don’t like what you see, here are a few ways to fix it:

  1. Save a large down payment.
  2. Transfer your debt to lower interest options. For example, you can switch from a high interest credit card to a lower interest credit card.
  3. Pay down your debts aggressively.

If you have any questions about debt-to-income ratios, please leave them in the comments below!

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