As tax season approaches, you may be considering using your tax return as a down payment on a large purchase. From my days in banking, I can tell you that this time of year often sees a surge in new loans, and sometimes I wish I could’ve had a conversation with clients about their debt-to-income (DTI) ratio before they made a purchase. If you’re thinking about making a big financial move, understanding your DTI is essential. Here’s what you need to know:
What is Your Debt-to-Income (DTI) Ratio?
Your debt-to-income ratio is a key metric that lenders use to determine how much credit you can qualify for. It helps them understand your current financial obligations in relation to your income. Essentially, it tells lenders how much of your monthly income goes toward paying off debt. To calculate your DTI, you divide your total monthly debt by your monthly income.
What Debt is Included in Your DTI?
Your DTI is based on certain types of debt, including:
- Monthly credit card payments
- Rent or mortgage payments
- Loan payments (e.g., car loans, student loans, personal loans)
- Alimony or child support
Items not included in your DTI are regular expenses like:
- Groceries
- Utilities
- Monthly subscriptions (Netflix, etc.)
- Insurance
For example, if your monthly income is $4,000 and your monthly debt payments total $1,000, your DTI is 25% ($1,000 / $4,000).
Why is DTI Important?
DTI is important because lenders use it alongside your credit score to determine whether to approve you for credit and what terms you’ll receive. A high DTI, typically above 43%, may signal to lenders that you have less flexibility in your budget and might struggle to handle additional debt. This could affect your eligibility for loans, especially for larger purchases like homes, and could result in higher interest rates.
Even if your DTI is low, it’s crucial to consider your overall financial picture before taking on new debt. Do you have an emergency fund? Are you contributing to retirement savings? These are important factors that could impact your financial health.
If you’re still with me and want to dive deeper into how DTI might affect your future financial decisions, feel free to schedule a 15-minute phone call with me. Together, we can explore how financial coaching might be the right move for you.
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