The median age of first-time homebuyers in the U.S. is 32, according to the National Association of Realtors — a number that has steadily increased in the past 25 years.
There are many reasons why it’s getting more difficult for young people to purchase their first home. But one contributing factor is that more young people today are saddled with student loan debt than they were in decades past, and this debt affects their debt-to-income (DTI) ratio.
During the approval process for a mortgage and other forms of loans, a lender will calculate a borrower’s DTI ratio. This number takes someone’s gross monthly debt payments and divides them by the person’s gross monthly income, according to the Consumer Financial Protection Bureau (CFPB).
Lenders use this number to assess whether a borrower has enough income coming in each month to pay their mortgage and all their other debts.
“When applying for credit, potential lenders will look at this ratio to see if you are a prudent risk for them to take [on] or if you are overextended,” said Luis Rosa, a certified financial planner with Build a Better Financial Future in Henderson, Nev. “The lower the debt-to-income ratio, the stronger you appear as a borrower in the eyes of the lender.”
Is your debt-to-income ratio good?
If you’re trying to secure a mortgage or other form of credit, it is wise to figure out your debt-to-income ratio before you start shopping, as different loan types have different requirements. To secure a qualified mortgage, for example, you’ll need a DTI of 43% or lower, according to the CFPB.
But, depending on the type of loan and your credit profile, the DTI requirement for mortgages can range from 31% to 50%, according to Experian.
Generally speaking, a DTI of less than 36% is what you should strive for. A DTI between 36% and 43% is OK, but it’s something you should try to lower before shopping for a mortgage. If your DTI is above 43%, you will likely struggle to secure a mortgage.
When it comes to other forms of loans, such as personal loans and auto loans, the DTI requirements can vary by lender. For example, Wells Fargo says a DTI of 35% or less is “looking good,” while there is “opportunity to improve” if your DTI is between 36% and 49%.
Calculating your debt-to-income ratio
Calculating your debt-to-income ratio is a fairly simple process. First, add up all your monthly debt payments — things like student loans, auto loans and personal loans. Then, divide that number by your gross monthly income, which is what you earn before deductions and taxes.
Here’s an example: Let’s say you will be paying an estimated $1,250 a month on a mortgage, and you currently pay $200 a month for an auto loan, $300 a month for a personal loan and $350 a month for student loans. That means your monthly debt payments would be $2,100. Let’s say your gross monthly income is $6,000 a month (meaning your salary is $72,000 a year). To calculate your DTI, you would divide $2,100 by $6,000, giving you a ratio of 35%.
You can also use this calculator to figure out your DTI.
Why your debt-to-income ratio matters
DTIs are most commonly used by mortgage lenders, but they’re also used by lenders who are approving other types of loans. For example, a DTI might be calculated when applying for a personal loan or a car loan, or when trying to refinance student loans. (DTI requirements are typically less stringent when applying for a personal loan or auto loan.)
How to improve your debt-to-income ratio
If your DTI is higher than you’d like it to be, there are a handful of ways you can lower it.
“Lowering your debt-to-income ratio comes down to one of two things: Making more money, lowering your debt, or a combination of both,” Rosa said.
Below are a handful of ways you can improve your DTI:
- Take on a side gig or ask for a raise. Taking on a side gig for a period can be a great way to up your monthly income. “With the same amount of debt and increased income, your debt-to-income ratio will go down,” Rosa said. You can also ask for a raise at your current job.
- Take another look at your budget. If you don’t have a budget, create one. If you do have one, take another look at it to see if there are areas where you can cut back to create additional income. This extra income can be used to accelerate your debt payoff strategy, which will lower your DTI, Rosa said.
- Pay off your highest debt first. If you’re looking to lower your DTI quickly, Rosa advises paying off your debt with the highest minimum monthly payment first since this is likely the account that is affecting your DTI the most.
- Consolidate your debt. Consolidating or refinancing your debt might be a way to get a better rate and/or longer terms, which could lower your monthly payments, Rosa said. Just consider that if you take this route, you might be paying more in interest long term.
Improving your DTI before applying for a loan is a step in the right direction. It can help you ensure not only that you’ll secure a loan, but that you’ll get one with optimal terms.
Interested in a personal loan?Here are the top personal loan lenders of 2019!
|Lender||APR Range||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Includes AutoPay discount. Important Disclosures for Payoff.
3 Important Disclosures for FreedomPlus.
4 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
5 Important Disclosures for LendingPoint.
6 Important Disclosures for LendingClub.
All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage & history. The APR ranges from 6.95% to 35.89%*. The origination fee ranges from 1% to 6% of the original principal balance and is deducted from your loan proceeds. For example, you could receive a loan of $6,000 with an interest rate of 7.99% and a 5.00% origination fee of $300 for an APR of 11.51%. In this example, you will receive $5,700 and will make 36 monthly payments of $187.99. The total amount repayable will be $6,767.64. Your APR will be determined based on your credit at the time of application. The average origination fee is 5.49% as of Q1 2017. In Georgia, the minimum loan amount is $3,025. In Massachusetts, the minimum loan amount is $6,025 if your APR is greater than 12%. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months. Borrower must be a U.S. citizen, permanent resident or be in the United States on a valid long term visa and at least 18 years old. Valid bank account and Social Security number are required. Equal Housing Lender. All loans are subject to credit approval. LendingClub’s physical address is: LendingClub, 71 Stevenson Street, Suite 1000, San Francisco, CA 94105.
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8 Important Disclosures for Avant.
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** Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33
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|5.74% – 16.99%1||$5,000 - $100,000|
|7.54% – 35.99%||$1,000 - $50,000|
|7.99% – 35.89%*||$1,000 - $50,000|
|5.99% – 24.99%2||$5,000 - $35,000|
|5.99% – 29.99%3||$7,500 - $40,000|
|6.79% – 20.89%4||$5,000 - $50,000|
|9.99% – 35.99%5||$2,000 - $25,000|
|6.95% – 35.89%6||$1,000 - $40,000|
|6.99% – 18.24%7||$5,000 - $75,000|
|9.95% – 35.99%8||$2,000 - $35,000|