Debt-to-income ratio is the amount of money you earn per month divided by your monthly debt payments. The higher your salary is and the lower your debt payments are, the better your score. But if your income isn’t high enough to cover all of your expenses, it can be a problem.
What is the debt-to-income ratio?
Debt-to-income ratio (DTI) is a measure of the amount of money that a borrower can afford to pay for their monthly debt obligations. It’s calculated by dividing total monthly debt payments by gross monthly income.
The DTI can be used as a screening tool when applying for any type of loan, and lenders will look at this ratio to determine what kind of loans you qualify for and how much they’ll lend you based on your DTI.
Why is it important?
The debt-to-income ratio is used to evaluate the risk associated with lending money to a borrower. The higher the ratio, the greater the risk that you won’t be able to make your monthly payments on time and pay off your debts. At a certain point, this will result in an inability to repay your debts and defaulting on them — which can lead to losing financial credibility and possibly even bankruptcy.
The lower you keep your debt-to-income ratio, however, generally means that you’re more financially stable and reliable as a borrower because it indicates that you have more disposable income than expenses — meaning that there is enough left over every month after paying for necessities like food and shelter for paying down existing loans faster than someone with more expenses relative to their income might be able (which makes sense).
How to calculate the debt-to-income ratio for businesses?
The best way to calculate your D/I ratio is by using a financial calculator. There are many online calculators that can be used for free, or you can use the one provided by your bank. It is important that you make sure that the results are accurate and not rounded up or down too much.
What happens if you have a high debt-to-income ratio?
The lender may not approve your loan application. This is probably the worst-case scenario and usually only happens with small business loan, but it’s something to be aware of. If you have too much debt relative to your income, you won’t qualify for a business loan unless you can make up for it somehow.
The lender may require you to pay a higher interest rate on loan. As per the experts at Lantern by SoFi, “Because startups can present higher risk to lenders, interest rates can be higher than other forms of financing.”
This isn’t ideal either, but if you can afford it and still make payments every month, then this shouldn’t be an issue for long—and it’s better than having no access at all!
When you’re looking to buy a home or expand your business, it’s important to have a good grasp of what debt-to-income ratios are and how they affect you. If your debt-to-income ratio is too high, it can make it more difficult to get approved for loans. On the other hand, if the ratio is low enough (or even better: zero!), then chances are much higher that lenders will be interested in working with you.
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