Many of us wake up confidently to apply for a loan only to find ourselves disappointed that our application has been rejected for reasons that really leave us scratching our heads.
“Wait but I checked my credit score this morning, I have great credit so why was my loan declined?”
“I make six figures a year, I have a lot of money so why can’t I get a loan?”
“I am not even applying for much so why am I getting rejected?”
TOUGH LOVE
The questions above arise every time we find ourselves on the decline list. Something you may not be aware of, is that your DTI (Debt to Income ratio) has a lot to do with it. Yes your credit score is very important. A high credit score shows lenders that you are a responsible citizen. You pay all of your debts on time and that is wonderful! YAYYYYY! But the other important factor is do you have too much debt? Enough to leave little to no room for you to be able to borrow anymore. That, is where your DTI comes into play.
First, let’s address the pink elephant in the room…
WHAT IS DEBT TO INCOME RATIO?
DEFINITION: Your debt-to-income ratio is all your monthly debt payments divided by your gross monthly income. This number is one method lenders use to measure your ability to make your monthly payments to repay the money you have borrowed.
BREAKDOWN
The most important thing about lending money is in the definition of the word LENDING itself from the perspective of a lender. The way they see it, lending is supposed to be refundable. So when someone lends you some money, it isn’t yours to keep but there is an expectation that the loan will be paid. That, is how lenders look at the overall picture of your finances through your DTI.
You can sit in front of someone and tell them that if they let you borrow XY&Z you promise that you will pay them back in due time. Perhaps this might work with your friend, neighbor, husband, wife or grandparents. You can establish that trust with those people. But at the end of the day, there is a chance that you may not get them the loan back. You could wake up and decide not to pay for the loan or take up to 30 years to pay for it. That is called RISK and lenders are never going to take a chance with RISK.
FACTS
Your DTI will show your lenders nothing but facts; you can sell them all of the stories in the world but it will mean nothing. At the end of the day they will look at how much your owe, who you owe, and how you are making those payments. Along with that, they will evaluate your income and how you are able to make those monthly payments. Only then will they be able to see where the loan you are asking for fits in. How will you manage to pay them back what you have borrowed along with all of your debts on your income?
CALCULATE DEBT TO INCOME RATIO
In order to calculate your Debt to Income Ratio you need to determine your monthly gross income and your monthly debt payments. Remember your monthly gross income is your income before taxes, not the amount left-over that actually makes it into your bank account. Your monthly debt includes items like mortgage, auto loan, credit card payments, etc.
So for example if you have a $2,000 monthly mortgage, a $150 a month auto loan, and $300 of credit card payments, your monthly debt payments are $2,450. If your gross monthly income is $7,000, then your debt-to-income ratio is 35 percent.
($2450 is 35% of $7000).
Ideally 43% is the highest a borrower can have and still be qualified for a loan; if you are anywhere under that ratio with a standard credit score, then you are most likely going to be qualified.
DEBT-to-INCOME RATIO CALCULATOR
Use the form below to calculate your Debt to Income Ratio.
In Conclusion
At the end of the day, there are two things that you have to tell yourself before you walk into a lender’s office: Your credit AND your DTI. This is because you need good credit to show that you pay your debts on time and you are a model borrower. But you also need your DTI to show that you can make room for additional debt.
Hope that helps clear up any questions you may have on Debt to Income Ratio. Good luck with your next loan!