Your debt-to-income ratio is all your monthly debt payments divided by your gross monthly income.
To calculate your debt-to-income ratio, add up all your monthly debt payments and divide the figure by your gross monthly income. Your gross monthly income is the amount of money you earn before income tax is deducted. For example, if you pay INR 15000 a month for your home loan EMI and another INR 6000 a month to pay your car loan EMI and INR 4000 a month for your credit card bill, your monthly debt payments are INR 25000 (15000+6000+4000). If your gross monthly income is INR 70000, then your debt-to-income ratio is 35.7 percent.
Evidence from studies of mortgage loans suggests that borrowers with a higher debt-to-income ratio are more likely to run into trouble making monthly payments. The 43 percent debt-to-income ratio is important because, in most cases, that is the highest ratio a borrower can have and still get a Qualified Mortgage.
There are some exceptions. For instance, a small creditor can consider your debt-to-income ratio, but is allowed to offer a Qualified Mortgage with a debt-to-income ratio higher than 43 percent.
Big lenders may still make a mortgage loan if your debt-to-income ratio is more than 43 percent, even if this prevents it from being a Qualified Mortgage.
BREAKING DOWN ‘Debt-To-Income Ratio – DTI’
A low debt-to-income ratio demonstrates a good balance between debt and income. Conversely, a high DTI can signal that an individual has too much debt for the amount of income he or she has. A debt-to-income ratio smaller than 36%, however, is preferable, with no more than 28% of that debt going towards servicing a mortgage. While the maximum DTI will vary by lender, the lower the number, the better the chances for an individual to get the loan or line of credit.
How to calculate your debt-to-income ratio
Add up your monthly bills which may include:
• Monthly rent or house payment
• Monthly alimony or child support payments
• Education, auto, and other monthly loan payments
• Credit card monthly payments (consider the minimum payment)
• Other debts
Note: Expenses like groceries, utilities, gas, and your taxes generally are not included.
Divide the total by your gross monthly, which is your income before taxes.
The result is your DTI, which will be in the form of a percentage. The lower the DTI; the less risky you are to lenders.
There are two variations known as the front-end and back-end DTI.
A front-end DTI only considers all housing-related debt, including the mortgage payments, taxes, insurance, and homeowner’s association fees. A back-end DTI also includes all of your non-housing-related regular debts and monthly expenses, such as car payments, credit card debts, child support, and education loan payments.
If you find your DTI is problematic, what can you do?
• Cut spending: Obvious, but worth emphasising. If you have not done so already, organise your expenses into daily needs, essential bills, and wants. How many wants are you willing to give up or delay in order to buy a home?
• Control your credit: Keeping your credit card balance low is a positive move to reduce your monthly CC bills.
• Scale back your lifestyle goals: You can either consider buying a less expensive home that fits your current income or alter your spending and saving habits with the goal of qualifying for your preferred home in the future.
Don’t go into a mortgage application ignorant of your DTI. If you cannot afford the mortgage but buy the house anyway, your dream home can quickly become a nightmare.
Govt’s commitment to reduce debt-to-GDP ratio commendable and I believe domestic flows will sustain, says Ridham Desai, MD, Morgan Stanley.