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What is a Debt-to-Income Ratio (DTI)?
Understanding debt-to-income ratio is quite easy because it’s exactly what it sounds like.
A debt-to-income ratio, often abbreviated to DTI, refers to the quantitative relationship between a person’s monthly debt payments and their monthly gross income. DTI is one of the main ways lenders assess an individual’s ability to manage their monthly payments to repay whatever amount of money they plan on borrowing. The better the DTI ratio, the higher a person’s chances of loan approval.
Lenders for unsecured loans usually prefer a DTI of no more than 30-35%. This makes understanding debt-to-income ratio and what goes into calculating it important for those looking to secure a loan to start, operate or expand a business.
How to Calculate DTI
Just like understanding debt-to-income ratio is fairly easy, knowing how to calculate DTI is very simple, assuming you’ve already been keeping track of your debt payments and income.
Calculating one’s DTI is as simple as adding up all the debt payments you’ve made in a month and then dividing that number by your gross monthly income. Gross monthly income refers to the amount of money you earned prior to taxes and other deductions being taken out. Debt-to-income ratio is typically expressed as a percentage rather than a decimal number, so after dividing your debt payments by your income, you can multiply that number by 100 or move the decimal over two places to the right.
For example, if your monthly debt repayments are $2,500 and your monthly gross income is $5,000, your DTI is 50%.
How Does Your DTI Impact Your Credit Score?
Now that you know how to calculate DTI, you might wonder how DTI affects your credit score. Credit Bureaus don’t track your income so their credit scoring models don’t calculate or include DTI. But while DTI may not factor into your credit score, lenders will ask for your income and calculate your DTI, which has a huge effect on your ability to qualify for an unsecured loan.
How to Improve DTI in a Manageable Way
If you’re looking to increase your chances of getting approved for a loan or just want to improve your DTI for peace of mind, there are a few straightforward ways to do so. You can:
- Increase the amount you typically put towards paying off your debts.
- Avoid taking on added debt.
- Splurge less on larger, non-essential purchases.
To give yourself the best chance at hitting these goals, create a budget and stick to it.
Now that you understand debt-to-income ratios, you might have questions about how your DTI will affect your unsecured loan application. At Unsecured Funding Source (UFS), we’ll be happy to help you through what is needed from lenders to increase your chances of getting approved for an unsecured loan. Contact us today to get started!