Use this tool to help keep your debt in check and improve financial wellness.
Your debt-to-income ratio (or DTI) measures your monthly debt payment against your monthly income (before taxes or other deductions). To calculate your DTI, add your total monthly debt payments and divide them by your total pretax monthly income. For example, if you pay $200 a month toward your car loan and $800 toward your mortgage, your monthly debt payments are $1,000. For example, if your pre-tax monthly income is $4,000, your DTI is 25% ($1,000 divided by $4,000).
Guidelines vary widely, but generally, a DTI of 35% or less is what lenders prefer (closer to 20% is ideal). In contrast, a DTI over 45% is likely to be considered problematic. Lenders use your DTI ratio to measure your ability to manage debt. So, having a low DTI is very important, especially when buying a home, car, or other significant assets. The following are some ways to lower your DTI ratio.
Pay Off Debt
Surprise! While it’s easier said than done, reducing your debt can help you reduce your monthly payments. Therefore, the percentage of your monthly income goes toward debt. Aside from lowering your DTI, paying off your debt can also improve your credit score by reducing your credit utilization ratio, which is your total debt divided by your total available credit. A higher credit score could help improve your chances of qualifying for a mortgage or getting a favorable interest rate.
Increase Your Income
Increasing your income is another way to reduce your DTI. You might increase your income by working toward a work promotion, working overtime, or picking up a second job or side gig. You will have a higher gross income for the calculation, but you’ll also have the opportunity to put more money toward your debt, further reducing your DTI.
Lower Your Monthly Payments
By reducing your monthly debt payments, you can reduce the percentage of your income you use for debt. There are several ways to lower your monthly payments, including refinancing your loans or negotiating the interest rate on your debt. While negotiating your interest rate may be possible for credit cards, installment loans — like personal loans, auto loans, or student loans — will likely require a refinance to adjust the rate.
Reduce Your Nonessential Spending
Look at where your money is going every month and cut back as much as possible. For example, are you paying for things like subscriptions that you no longer need? Freeing up that extra money in your monthly budget means you’ll have more available to pay off debt. And the more quickly you can pay off debt, the faster you can reduce your DTI.
Increase Your Down Payment
When lenders calculate your DTI, they consider the impact of a mortgage loan on your finances and aim to keep your DTI with your mortgage under a certain level. You can reduce your DTI when you own a home by putting down a larger down payment, which will result in lower mortgage payments each month.
Today, we are more responsible than ever for our retirement success, unlike any other generation before. Economic conditions are constantly changing. Strategies that worked yesterday may not work in a modern economy. With an overwhelming number of financial products, strategies, and varying opinions, it is more important than ever to take a proven methodical approach to wealth management.
Make sure that you are taken care of when it comes to your wealth management, and choose an advisor that you know is on your side!