Your debt to income ratio is the percentage of the monthly income used in paying debt. Having a lower DTI ratio is important because it means you don’t spend a large chunk of your income on paying the debt.
When you have a high DTI ratio, it means you are using a lot of your income on paying debts. And that, in turn, means you are left with less money to spend on other bills or savings. Obviously, that’s not good for your finances and probably not good for your mental health either.
Having a low ratio gives you access to cheaper credit terms when you need to borrow money from a lender.
So, keeping this ratio as low as possible is important.
This article will show you how to determine what your debt to income ratio is and what you can do to lower it.
Ready? Let’s get started.
Figuring Out Your Debt-to-Income Ratio
Figuring out your ratio is not difficult at all. Just grab yourself a calculator and do the following.
Get the total for all your monthly debt payments.
This will consist of your mortgage payments, car payments, credit cards and any other loan you may have. Then, divide that total by your monthly income.
If you have more than 50% debt-to-ratio, then it is a sign that you are overloaded with debt. This means more than half of your income will go to servicing debts.
A debt-to-income ratio of 36% or lower is considered optimal when trying to qualify for a loan with any lending institution. The lender will see that your debt isn’t beyond what you can afford to pay.
Having a high ratio is not good for many reasons. You will have a hard time paying your bills because much of your income is going to debt. It will also make any lender think twice about lending you money for a mortgage and car loans. Lenders will make sure you are in a position to pay the loan easily.
How Can You Reduce Your Ratio?
There aren’t many ways to improve your ratio. Your first option is to increase your income. You can accomplish that by putting in extra hours at work, taking a part-time job, asking for a salary increase, earning money from something you are interested in that has profit potential, or starting a business.
If you put in the necessary work, you could substantially decrease your debt-to-income ratio.
The other option is to pay off your debt. During the process of repaying your debt, your ratio will increase temporarily because you are devoting more of your monthly earnings on your debt repayment.
This is due to the fact that a larger portion of your income is being used for debt instead of savings. Let’s say you earn $3,000 per month and you are currently spending $1,500 on debt, then the ratio is 50%.
When you spend $2,100 on your debt, then the ratio increases to 70%, but once you are done paying the debt, the ratio will go to zero because you are no longer spending your income on paying any debt.
The bottom line is that you will have to earn more money, cut expenses dramatically, or do both of those things to lower your debt-to-income ratio. There’s no other way around it.
Cut Back on Your Spending
You should try redoing your budget if you want to see positive results. This is where you should consider cutting back. Choose less expensive alternatives, and reduce the frequency of certain expenses instead of getting rid of them altogether. You should have a realistic plan so that you follow it through and achieve your financial goals.
You should start by paying off the smallest debt. A one-hundred-dollar credit card that needs a minimum monthly payment can have an impact on your DTI ratio. Pay them in full. This small tip can have a lot of impact on your ratio.
Look for ways of refinancing high APR credit cards with a low APR card. APR is the interest you will be paying over a period of one year. This is a good way to look at the amount of interest you are paying instead of looking at misleading introductory rates.
Lenders will be happy to provide you with attractive APRs when you have a good credit rating. If the cards you have are past the introductory period, there is a good chance you are paying a higher APR than you need to. Doing this will help you reduce the amount you are paying and this will lower the ratio because it means less of your income will go to paying debt every month.
You will always find a way to refinance your long and short-term goals to take advantage of lower rates. Lower rates will mean a lower monthly debt repayment amount.
The lower ratio will benefit you in many ways, with one of the most common being able to access less-expensive credit.