Most people have debt, which is not necessarily a bad thing. Few people buy a home outright, for example; when you have a mortgage, you have debt. What is important is managing the amount of debt you have. To do this, figure out your debt-to-income ratio, also called your DTI, which is the amount of debt you carry compared to how much money you earn.
Figure Your DTI
Figure out your DTI by adding up all of your debts that you pay on a regular basis. This might include your mortgage, a home equity loan, car loan, student loan and credit card payments. Don’t include ordinary expenses, such as groceries, gas and utilities. After you add up your debts, take the total and divide it by your gross monthly income. This number is your DTI.
Your DTI should be less than 36 percent to be considered a good debt ratio in the eyes of lenders. If your DTI is more than 36 percent, you might not be able to get a loan, or if you do get one, your interest rate will likely be higher. Lenders care about your DTI because if you have too much debt compared to your income, you are in a precarious position. If something were to happen to upset the balance, such as losing your job or taking on more debt, you might not be able to pay back your debts.
Your DTI is a number that lenders look at in addition to your credit score. Your credit score is based on five factors: your payment history, amounts owed, length of credit history, new credit and types of credit. If you have a good DTI, you can use that to your advantage when negotiating a loan, according to Dave Hinnenkamp of KDV Wealth Management on Bankrate.com. If you have a short payment history, for example, you can point lenders to your low DTI to help the decision go your way.
Play It Safe
Play it safe by keeping your DTI below 30 percent. That way, you can better afford a few luxuries, such as entertainment and going out to dinner. Also, if your DTI is too high, an emergency, such as an illness or job loss might mean you could lose your home or your car. One way to cut down your DTI is to pay off your credit cards. Once you do that, pay off your other debts as long as you don’t have a prepayment penalty attached. Keep your spending in check. Just because you qualify for a loan doesn’t mean you have to take it.