Understanding your debt-to-income ratio

Keeping tabs on your debt levels is important in your personal financial planning. In one of our recent posts here, we talked a bit more about budgeting. Understanding your debt-to-income ratio (DTI) is helpful when you’re preparing to apply for different types of credit, including a mortgage.

What exactly is your debt-to-income ratio (DTI)?

Your DTI is relatively simple to calculate. You take your monthly debt payments and divide it by your income to determine the percentage of income, before taxes, you will need to cover your debt payments. This is used to gain a better understanding of your financial position relative to how much money you’re making.

How can this impact my mortgage approval?

When you decide it is time to buy a house and get a mortgage, lenders will use your DTI to determine how much money they are willing to loan you. This can have an impact on the type of home you are able to purchase. A lower DTI indicates lower risk to the lenders.

Lenders like to see a personal DTI Ratio of 36 per cent or less. Higher DTI indicates higher risk. When you have a higher DTI, you may need to have a higher credit score or put a larger down payment on your new house purchase. This may also include needing to secure private financing where you will pay a higher interest rate to cover the increased risk to the lender.

How can I improve my debt-to-income ratio?

Improving your DTI comes down to two things: Increasing your income or reducing your monthly debt obligations. The former is usually the more challenging option but it’s never been easier to start a side-hustle to bring in some extra income.

There are a number of ways to improve your DTI. These include:
– Paying down your revolving, often unsecured, debt as you build surplus cash
– Trying to manage your debt before it gets out of control. You should not be paying off debt with more debt.
– Using extra savings you have to pay down your debt. Having low/no equity without debt is seen as more favourable than more equity with high debt.

If your debt-to-income ratio is 50 per cent or above, it might be a good time to talk to your bank or lender about restructuring your debt to help pay it down quicker.

Understanding your debt-to-income ratio is one part of your financial picture. We will be talking more about income, assets, and credit throughout Financial Literacy Month! You can check out more about that here.

As always, if you have any questions around debt-to-income, or how it impacts your financial situation, please get in touch with us here!