4 Tips for Improving a High Debt-to-Income Ratio

 It’s impossible to even begin to estimate someone’s financial health based on their income alone. Sure, it’s easy to assume someone making $150,000 or more is pretty set financially — and perhaps in a better financial situation than someone making $50,000 annually. But the earnings are only half the equation here. If the higher earner has $100,000 in credit card debt, while the lower earner has a modest $5,000, the tables turn.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 In other words, it’s important to assess both debt and income when you’re evaluating your financial health. Luckily, there’s a ratio measuring those exact two factors, aptly named the debt-to-income ratio (DTI). Let’s take a closer look at this calculation, as well as how to improve yours.


Calculating Debt-to-Income Ratio
 
Put simply, DTI measures the percentage of your income that goes toward paying off debt. To find yours, divide the sum of your monthly debt payments by your gross monthly income. Multiply the result to turn the decimal into a percentage. So, if you make $3,000 per month and spend $900 on loans and debt, your DTI would be 30 percent.

High DTI makes you appear riskier to lenders, because more of your money has to go toward servicing your debts each month. In the eyes of lending institutions, this makes you seem more likely to have difficulty making payments on subsequent loans. If too large a percentage of your earnings go toward debt, you may be denied additional loans or lines of credit as a result. For reference, the highest DTI you can have to get a Qualified Mortgage is usually 43 percent.

Low DTI makes you appear more attractive to lenders based on the fact you’re not overextended.

Improving Your Debt-to-Income Ratio
 
So, you’ve calculated your DTI and now you want to optimize it. But how? The broadest way to summarize the following advice is: Make more money or decrease the amount of debt you’re carrying.

More specifically, consider these strategies from Experian:

- Pay down credit cards or loans more aggressively, which may require revisiting your budget to free up extra funds.

- Press pause on taking on new debts until you’ve worked down your existing ones.

- Explore ways to eliminate debt if you’re struggling to pay it down — like various forms of debt consolidation, debt management or debt relief programs.

- Figure out how to get a raise at your current job, taking on a side hustle or making a career move to a higher-paying position.

Why Debt-to-Income Ratio Matters

Your DTI is not a factor directly considered by credit reporting bureaus when they’re formulating your score. However, DTI is closely related to your debt-to-credit ratio — which measures how much of your available pool of credit you’re currently using. Paying down debts can not only help your DTI change in your favor, but also make your credit utilization ratio go down in a way that can boost your credit score.

Although DTI does not directly influence your credit rating, it does influence whether lenders will approve your application or not — be it for a new credit card, a personal loan or a mortgage.

A high DTI tells the world most of your earnings automatically go toward furnishing your debts each month, meaning you have less left over for other things — especially a new obligation. Getting your DTI in check now can help spare you a headache when you need to apply for credit in the future. This is just one reason why it behooves borrowers to figure out how to work down their debts and maximize their incomes in the present. The fact that eliminating debt can also improve your credit utilization rate — and thus your credit score — is a another bonus.
 
 
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