If you’re considering purchasing a home within a year to six months, now is the time to start preparing your finances to make yourself the best loan candidate possible. Part of this preparatory process is ensuring you have a healthy debt to income ratio (usually called DTI ratio). A DTI ratio is a part of what lenders consider when evaluating borrowers, and will be a large factor in determining your terms and loan amount. Here, we will help you understand the basics of DTI ratios, and give you ways to improve it.
How Is DTI Determined?
Your DTI ratio is how much debt you have compared to how much you make a month. To calculate your DTI ratio, add up all the payments you make toward your debt during an average month. This amount should include your monthly credit card payments, car loans, student loans, alimony, or any other kind of debt you are paying off. When calculating your credit card debt, add up the monthly minimum payment instead of the whole amount due. When you have you have established your monthly debt payments, divide that number by your monthly gross income. Take this number and multiply it by 100 for a percentage. This percentage is your DTI ratio.
Where Do I Want My DTI Ratio To Be?
The range of DTI ratio acceptable to lenders is between 36% to 50%, though some may accept more or demand less. 36% DTI ratio or lower is considered excellent, 43% is good, and 50% is the maximum you want to have. Those in the higher range may only qualify for particular loans, most of which have monthly PMI attached.
Ways To Improve Your DTI Ratio
Most the ways you can improve your DTI ratio are not overnight fixes. They require some time to be established and take effect. This is why it is important to begin your financial preparations for purchasing a home as soon as possible. Here are a few ways to get your percentage into a healthier range.
1. Increase Your Income: This is a tougher one, but if you can increase you earnings in the year before applying for a loan, your DTI ratio will be healthier for the application process. Whether it’s asking for a raise, selling some things you no longer need, or picking up a side gig, find ways to raise the amount of your gross income.
2. Lower Your Monthly Debt Obligations: In the months leading up to your loan application make debt payment a priority. Consider putting some retirement or other savings on hold for a temporary time to make larger payments toward your debt.
3. Address Your Credit Cards: Consolidating your debt may be a helpful way to begin this process. After which you can start prioritizing paying off your credit card debt. Try to make more than the monthly payment. Don’t close any cards, though, it will negatively affect your credit score.
4. No New Loans: Now is not the time to purchase a new car or take out a personal loan. Avoid any large purchases that require you to go into debt.
5. Avoid Debt By Creating a Budget: A good budget will help you see where your money is going each month and track where you’re overspending. With the money you save from having a good budget, you can pay down some of your debt and improve your DTI ratio.
Questions? We Want to Help
If you have more questions about DTI ratios or are looking for ways to prepare for a loan application, give us a call at (949)-373-5834. We’d love to help walk you through every step of the homebuying process.