The Importance of Understanding Debt-to-Income Ratio

Author: Johnnie Medrano, Regional Retail Sales and Service Manager 10/10/2023

If you’re in the market for a new car, a home, or even paying for college, chances are you plan to borrow money to cover those expenses. But before your lender just hands over the money, they need to know how much risk you pose. Will you be able to repay the debt?

A credit score is one way to show your financial responsibility, but there’s another important factor in revealing your track record—Debt-to-Income (DTI) Ratio.

How to Measure Your DTI Ratio

Your Debt-to-Income Ratio is…

The Amount of Your Required Monthly Debt Payments

÷

Your Gross Monthly Income (pre-tax earnings)

When calculating your monthly debt payments, include everything—credit card payments, car loan payments, student loan debt, mortgage, etc. If you are required to pay it monthly, it should be calculated. Then figure out how much money you make each month before taxes. Divide the numbers, and there’s your Debt-to-Income Ratio.

When you’re looking to establish credit, this number is very important. It also affects your credit rating. If it’s too high, your credit score decreases, and banks may question your ability to repay loans. Even if you pay your debt, a higher number is seen as riskier. If the risk is elevated, this affects your credit score.

What My DTI Ratio Says About My Financial Health

Your Debt-to-Income Ratio is one of the best measurements of your financial health. It’s an easy way for banks to evaluate risk. The number doesn’t mean you’ve missed payments or aren’t trustworthy. But for a bank, there are only so many ways to evaluate risk.

Is My DTI Ratio Too High?

Typically, banks want your DTI Ratio to be under 35%. Some banks may be willing to mitigate the risk with higher finance fees, but on a standard conventional loan, most banks will want you below 35%.

How to Lower My Existing Debt

If you’ve read this far, you now know that your Debt-to-Income Ratio is all about how much debt you potentially could carry. If it’s too high, this could raise a red flag to banks if you plan to borrow money.

To help lower your existing debt, work on lowering that top number in the DTI Ratio—your required monthly debt payments. Consolidation isn’t going to help a lot, but making larger payments on your credit card or your loans will make an impact. Lowering the top number lowers the ratio.

Lowering your DTI Ratio can go a long way toward helping you acquire a home loan, too. A home loan is a big risk for a bank and often spans several decades (30 years typically), so your DTI Ratio is very important.

PlainsCapital Bank is here to help you on your financial journey, whether that includes lowering your Debt-to-Income Ratio, managing your money, or applying for a loan. Schedule an appointment today at your local branch or visit us online.

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