What percent does a lender generally look for when considering a loan?
When it comes to borrowing money, lenders want to know one thing: can you afford to repay the loan? This is where the debt-to-income ratio (DTI) comes in. Your DTI is a simple calculation that compares your monthly debt payments to your monthly gross income It’s expressed as a percentage, and the lower the percentage, the better.
Why is the DTI so important?
Lenders use the DTI to assess your ability to manage your debt. A low DTI means you have plenty of room in your budget to make your monthly payments. A high DTI, on the other hand, suggests that you’re already stretched thin and may have difficulty making your payments on time.
What is a good DTI?
Depending on the lender, the ideal DTI varies, but generally speaking, a DTI of 36% or less is regarded as good. This indicates that a maximum of 33.6 percent of your gross income is allocated towards debt repayment. While certain lenders might be open to going as high as 2043%, anything over that is deemed risky.
How can I improve my DTI?
There are a few things you can do to lower your DTI if it’s too high:
- Pay down debt. This is the most effective way to lower your DTI. Focus on paying off high-interest debt first, such as credit card debt.
- Increase your income. This will give you more money to work with, which can help you lower your DTI.
- Reduce your expenses. This will free up more money that you can use to pay down debt or increase your savings.
What if my DTI is too high?
If your DTI is too high, you may still be able to qualify for a loan, but you may have to pay a higher interest rate or make a larger down payment. You may also need to provide additional documentation to the lender, such as a budget or a letter of explanation.
The bottom line
The DTI is an important factor that lenders consider when making loan decisions. You can raise your chances of being approved for a loan and obtaining the best terms by being aware of your DTI and taking action to improve it.
Additional Resources
- Investopedia: Debt-to-Income Ratio
- NerdWallet: Debt-to-Income Ratio Calculator
- Bankrate: How to Calculate Your Debt-to-Income Ratio
FAQs
- What is the difference between the front-end DTI and the back-end DTI?
The front-end DTI compares your housing expenses to your gross income. The back-end DTI compares your total debt payments to your gross income.
- What is a good front-end DTI?
A good front-end DTI is 28% or lower.
- What is a good back-end DTI?
A good back-end DTI is 36% or lower.
- What happens if my DTI is too high?
You may still be able to qualify for a loan, but you may have to pay a higher interest rate or make a larger down payment. You may also need to provide additional documentation to the lender.
Disclaimer: I am an AI chatbot and cannot provide financial advice.
Debt-to-Income Ratio Example
John is looking to get a loan and is trying to figure out his debt-to-income ratio. Johns monthly bills and income are as follows:
- mortgage: $1,000
- car loan: $500
- credit cards: $500
- gross income: $6,000
Johns total monthly debt payment is $2,000:
Johns DTI ratio is 0.33:
In other words, John has a 33% debt-to-income ratio.
Real-World Example of the DTI Ratio
Wells Fargo Corporation (WFC) is one of the largest lenders in the U. S. The bank provides banking and lending products that include mortgages and credit cards to consumers. Below is an outline of their guidelines of the debt-to-income ratios that they consider creditworthy or need improvement.
- It’s generally considered favorable to have 35% or less, and your debt is manageable. You likely have money remaining after paying monthly bills.
- 36% to 2049% indicates that while your DTI ratio is adequate, there is still room for improvement. Lenders might ask for other eligibility requirements.
- A 50% or higher debt-to-income ratio indicates that you have less money to save or spend. Because of this, you probably won’t have enough money to deal with an unexpected expense and won’t have many borrowing options.