As consumers rack up more debt each year, it’s important for individuals to keep an eye on their debt-to-income (DTI) ratio to ensure they’re spending responsibly.
What is a debt-to-income ratio?
Your debt-to-income ratio measures the amount of debt you carry compared to your gross monthly income. And, it’s an indicator of your overall financial health. A high debt-to-income ratio suggests you’re spending too much relative to what you earn. And a low ratio suggests you have a healthy balance of debt and income.
How do I calculate my debt-to-income ratio?
The ratio is calculated by adding up your recurring monthly debt payments and dividing the total by your gross monthly income. Examples of debt payments used in the calculation include monthly payments for mortgages, auto loans, credit cards, student loans, child support, alimony and more. It does not include monthly expenses such as groceries, utilities and phone bills.
Your gross monthly income is the total amount of money you earn each month before taxes and other deductions (retirement, health insurance, etc.) are withdrawn from your paycheck.
For example, if your gross monthly income is $5,000/month, and you pay $1,200/month for your mortgage, $250/month for your auto loan and $300/month for your remaining debt, then your debt-to-income ratio is 35 percent. ($1,200+$250+$300 = $1,750/$5,000 = .35 or 35 percent)
It’s also important to note that the amount is based on your minimum required payments due, not the payments you actually make each month.
Why does my debt-to-income ratio matter?
Your DTI ratio is one of the criteria lenders consider when deciding whether to approve you for a loan or line of credit. It’s used in conjunction with other factors such as your income and credit score to measure your ability to repay your debt.
Most lenders require a debt-to-income ratio of less than 45% to get a qualified mortgage. In general, the lower your ratio, the better your chances of qualifying for a loan, because it indicates you have money left over after paying your bills each month. And, a high debt-to-income ratio indicates you’re stretched thin financially.
But, at the end of the day, it’s up to you to decide how much debt you can comfortably afford to take on, regardless of what the lender says.
How can I lower my debt-to-income ratio?
There are two ways to lower your DTI ratio. You can either increase your income or reduce your debt. If you want to get even faster results, consider doing both. Here are a few tips to help you get started:
• Consider asking your current employer for a raise, getting a new position that pays more, or taking on a side job to generate additional income.
• Consider making more than your minimum monthly payments on your current debts. Not only will this help you pay off your balances faster, it may also reduce the amount of interest you pay over the life of your loans.
• Review your expenses. Identify items you can eliminate from your budget and areas where you can cut back until your financial situation improves. Use the money you save to pay off existing debt.
• Consider getting a debt consolidation loan. These loans combine multiple debts into a single monthly payment, often at a lower interest rate, which can quickly save you money. You can often extend the term of the repayment, further lowering your monthly commitment since it is spread out over a longer term. However, this could cause you to pay more money in interest in the long term, because you will have the outstanding debts for longer. But you could improve your ability to incur additional debts because you have greater cash flow and a lower debt-to-income ratio.
Does my debt-to-income ratio impact my credit score?
A variety of factors are used to calculate your credit score, including:
• Your payment history
• Your current unpaid debt
• The mix of credit accounts you have
• The length of your credit history
• The amount of available credit you’re using
• How many new credit applications you have
Your debt-to-income ratio isn’t one of them, so it won’t directly impact your credit scores. But, because of the way scores are calculated, the amount of debt you carry can indirectly affect your score.
For example, if you have a high DTI ratio, there’s a good chance your unpaid debt and the amount of available credit you’re using is also high. These factors could negatively impact your credit score.
Truliant can help
Truliant has a number of ways we can help you take charge of your debt. We offer free No-Cost Credit Reviews, during which we review your credit score and help find way to improve it. We can also conduct a free TruFinancial Checkup, which looks at your entire financial picture to help you find ways to save money. We also offer a number of personal convenience, debt consolidation, home equity and auto loans that can help consolidate your debt and lower your debt-to-income ratio. To learn more, set an appointment with one of our specialists at truliant.org/locations, or call us at 800.822.0382 to get started.