Understanding Debt to Income Ratio (DTI)
Getting a loan and buying a vehicle whether new or used can be a confusing experience. When your credit isn’t great, that experience can go from just a bit confusing to headache-inducing. There is a lot of information floating around out there about everything you have to consider, including your Debt to Income Ratio (DTI).
What is Debt to Income Ratio, and just how important is it?
Simply put, DTI is the percentage of your gross monthly income that goes to debt payments. This includes payments such as mortgage or rent, credit cards, car loans, and student loans. This ratio is used to determine the likelihood of your ability to repay a loan.
Your DTI does not affect your credit score, but it can affect your ability to qualify for some loans. Even if your payments have always been on time a high DTI could hurt your chances of obtaining more credit.
How is DTI Calculated?
Calculating your DTI is actually pretty simple, and can help you be prepared when applying for loans or more credit.
Step 1: Add all your gross income (that is income before taxes) from all sources. If you have more than one job, or a side hustle, be sure to include your income from there as well.
Salary before taxes: $3500/month
Babysitting Income: $400/month
Total Gross Income: $3900/month
Step 2: Determine all your payments as based on a report from the credit bureau. Make sure to include your rent if you do not have mortgage payments. Canadians can order a free credit report from both Equifax Canada and TransUnion Canada. Each credit bureau may have different information about how you have used credit in the past. This has no effect on your credit score. You can read more on credit scores and reports in our past blog posts.
Car loan: $330/month
Credit Card Payment (the minimum payment required per month, based on what you have owing): $100/month
Student Loan: $200/month
Total Payments: $1,830.00
Step 3: Divide your monthly debt (the number you calculated in Step 2) by your monthly income (found in Step 1).
Example: 1830 / 3900 = 0.47
Step 4: Multiply the number you got in Step 4 by 100 to get your final percentage.
Example: 0.47 * 100 = 47%
What is a good or bad ratio?
Different types of credit (mortgage, vehicle loan, credit card) you might be applying for will have different tolerances for DTI but a general rule of thumb:
35% or less = Good
36-43% = Acceptable but needs work
44% and up = Needs work
You can improve your DTI by paying off debt or increasing your income. This will likely take time, but a healthy DTI means a healthy financial situation and higher likelihood of approval when needing to apply for credit.
Keeping track of your DTI and keeping it as low as you can will help you get the approval you are looking for in your loans. At Direct2Wheels we help folks with bad credit move forward with a car loan designed to rebuild credit in a responsible way. We work with your budget to help keep your DTI from getting out of hand.