Originally Posted On: https://www.iquanti.com/
If you have significant debt, you may feel like your debt payments make up the majority of your monthly spending. And high debt payments compared to how much you earn can be a sign of financial stress and can make you appear as a higher lending risk when you want to take out a loan. If you’re curious about debt-to-income (DTI) ratio or think yours may be high, here’s what you need to know about how to calculate it and ways to lower it.
How to calculate your debt-to-income ratio
As you may have guessed, the debt-to-income ratio is a measurement of how much you’re paying in debt each month as a percentage of what you earn. Calculating your DTI ratio is simple if you follow these steps.
- Add up all your monthly debt payments. That includes debts like rent or mortgage, student loans, car loans, and credit card payments. So, for example, if you pay $1,000 per month in rent, $200 in student loans, and $350 on credit cards, your monthly debt payments total $1,550.
- Determine your gross monthly income. This number is a measure of your pre-tax income before any deductions are removed. So, if you make $45,000 per year, your gross monthly income is $45,000/12 or $3,750.
- Divide your answer for part 1 by your answer for part 2. Using our numbers above, the DTI ratio = $1,550/$3,750 = .41333333.
- Turn the decimal from step 3 into a percent by moving the decimal place. The debt-to-income ratio in our example is 41.3%.
How to reduce your debt-to-income ratio
Lenders have different requirements when it comes to your debt-to-income ratio, but typically, a ratio over 40% can signify that you may be a financial risk.
It may seem obvious, but there are two ways to reduce your debt-to-income ratio. You can either lower your debt or increase your income. With those two approaches in mind, here are 4 strategic ways to lower your DTI ratio.
Avoid taking on additional debt
If you’re serious about decreasing your debt-to-income ratio, you’ll want to immediately stop accruing more debt. That means you should rein in excess credit card spending and focus on creating and sticking with a reasonable budget. It also means you may want to delay any large purchases until your DTI ratio is under control.
Pay more toward your debt
The fastest way to decrease your existing debt is by making additional payments if you can. Unfortunately, that may mean you’ll need to cut back spending in other areas to free up more money for debt repayment.
If possible, you’ll want to make sure these payments go directly toward the principal, not interest. That means you’ll be able to make a dent in what you owe more quickly.
Lower your interest rates
If you can, lowering how much you’re paying in interest can significantly impact your overall debt burden. Consider calling your lenders to negotiate a lower interest rate, especially if you’ve been a long-time customer with a clean record of making timely payments.
If interest rates have gone down since you first got a loan, it may be time to discuss refinancing with your lender. As long as the refinancing fees are low, locking in a lower interest rate can significantly lower how much you’ll pay over the life of the loan.
Increase your income
Side hustles are a great way to bring in extra cash and boost your income. You can do jobs online from home like taking surveys for cash, freelancing as a writer, or teaching a class. If you’re more of a hands-on kind of person, consider driving for UberEats, picking up a shift at your local coffee shop, or preparing meals as a personal chef.
The bottom line
Your debt-to-income ratio is an important factor considered by lenders when you want to take on debt. And keeping your ratio lower than 40% can be a wise financial move. To lower your debt-to-income ratio, be sure to avoid taking on additional debt, make larger or more payments on existing debt, lower interest rates, and find ways to increase your income. Each of these moves will help put you in a much better financial position the next time you need to calculate your DTI ratio.
Notice: Information provided in this article is for information purposes only. Consult your financial advisor about your financial circumstances.