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Debt to Income Ratio and Why Its ImportantWhen you try to obtain a loan or mortgage, you will undoubtedly come across some terms that may sound like a foreign language to you. There is no cause for alarm, however. Your loan representatives job is to sit down with you and explain things to you in detail. One of the things that may be explained to you as being very important criteria for you to get your loan is the debt to income ratio. Basically, the debt to income ration, otherwise known as DTI, is an indicator of what your current financial condition is. This is one the lending institutions use to determine your fiscal health. To calculate approximately what your debt to income ration is, divide your minimum monthly debt payments by your gross monthly income. An example would be if your gross monthly income is $2,000 and you make minimum payments of $400 on your debt, you would have a debt to income ration of 20 percent. While the formulas may vary for different lending institutions, they do so only in a small amount. There are some lenders that may include your mortgage in the debt and others will not. Regardless of the particular formulas that are used, the overall idea of them is completely the same. The debt to income ratio simply weighs against your debt load to income. If you are looking to obtain a mortgage on your first home, by calculating your debt to income ration, youll get a more thorough idea of how much you can afford for your mortgage, as well as principal, interest, taxes, and insurance (These items are referred to as PITI). By most standards, an individuals total amount that is paid toward the mortgage (your PITI) should not be more than 28 percent of your total gross income and the amount you pay for all your debt, including your car loan payments, credit cards, student loans, mortgage, and any other debt you may have accumulated, should not go over 36 percent of your total gross income. Of course, there are some financial institutions that may have an amount lower than this to use as a guideline for approving loans. Obviously, one of the reasons your debt to income ratio is so important is that it lets the financial institutions know whether you can afford the payments on such a debt as a loan or a mortgage. A financial institution does not want to give out loans that they know you can not afford. Therefore, if your debt to income ratio is already high to their standards, you will have a difficult time obtaining that loan or mortgage. To protect yourself, you also should not be willing to take out a loan or mortgage that will exceed the debt to income ratio. While things may look great on paper for you and your budget, you have to look ahead and imagine what would happen if you lost your job for three months or even one. If your debt to income ratio is too high, you could never recover from a financial change due to unforeseen circumstances. It is best before you try to obtain a new loan or mortgage to calculate your debt to income ratio to calculate just how much you can afford.
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