Why does debt-to-income ratio matter? According to Fidelity.ca, the lower a person’s debt-to-income ratio, the healthier their financial picture is, and the more money they may be able to put in their bank account.
So, what it is?
What is debt-to-income ratio?
“Debt-to-income (DTI) ratio measures the amount of your monthly income that goes toward making debt payments,” according to the article.
It essentially expresses the amount a person owes in relation to how much they earn–as a percentage. Potential lenders reference a person’s DTI to determine whether to lend them money, according to Kingston CFP Jason Hare.
To explain it, let’s say a person earns $6,000 a month and total monthly payments come to $2,500. In order to calculate the DTI, divide $2,500 by $6,000 which equals 0.416 or close to 42%, according to the article.
Lenders look to DTIs when people apply for mortgages or personal loans as one of the factors they consider. In general, a DTI of 36^ or less makes it clear that a person can manage monthly payments, while a DTI of 42% can make lenders wonder if a person is in too deep.
It is good for people to personally assess their finances to make sure they can cover additional payments, especially if something goes wrong.
Four main benefits to keeping a DTI low
Simply put, a low DTI can make life easier. Carrying less debt means saving money on interest payments, which can equal more money saved for investment in the future and toward a quality way of life.
“People do not often realise how important a low DTI is until they really need it,” said Jason Hare.
1. Helps with loan qualification
DTI can impact everything from financing the purchase of a new oven, can impress potential lenders and mean better terms and a lower interest rate.
It will also help with a home loan: whether purchasing a new home, or refinancing a current loan, according to the article.
2. Allows for better advantage of financial deals
The opportunity to refinance an auto loan, for example: some deals exist at credit unions that can cut the interest rate of auto loans in half if refinanced. A low DTI will make deals like that more possible.
A low DTI and a high credit score help for people to qualify for the best possible financing rates available.
“These kinds of financial markers are essential when people are being assessed for financing,” said Hare.
3. It Can Indirectly Impact Credit Score
While credit reporting companies cannot look at a DTI because they do not record income, a DTI can still indirectly impact a credit score via carried rotating debt, like credit cards, which can affect credit utilisation rate, according to the article.
Credit utilisation is the second most important factor in calculating a credit score. It’s calculated by dividing the balance carried by total credit limits. It is suggested that people try to keep their utilisation rate.
Further, taking note of DTI can have a secondary positive impact: it can make people monitor how much credit they carry. “And the lower your credit card and other rotating debt, and the healthier your credit score is likely to be,” according to the article.
4. Provides Peace of Mind
It helps to know that there is not a lot of debt and that in an emergency there is credit that can be easily accessed.
Key ways to reduce DTI: “pay down debt, earn more money, say no to new debt, and encourage yourself,” according to the article.
A low DTI is worth pursuing as it provides stability.