Your debt-to-income ratio, or DTI, compares your debt payments to your income on a monthly basis. Itâ€™s an important measurement of how manageable your monthly budget is, as it reveals how much of your income is being devoted to payments on debt you still owe.
But itâ€™s even more important to be aware of your DTI if youâ€™re planning to apply for new credit soon. Hereâ€™s what you need to know.
A debt-to-income ratio is expressed as a percentage that represents how much of your monthly income goes toward debt repayment. So a DTI of 20%, for example, shows that your monthly debt costs are equal to 20% of your gross monthly income.
The lower your monthly debt costs and the higher your income, the lower your DTI. But if you borrow more or your income is lower, your DTI will be higher.
There are two types of debt-to-income ratios that a lender might consider.
Your front-end DTI compares your total housing or mortgage costs to gross monthly income. Itâ€™s sometimes also called your housing-expense-to-income ratio. This is based on your full mortgage payments if you have a mortgage, and would include principal, interest, property taxes, homeowners association fees and insurance costs. If you rent, it would be your monthly rent amount. It doesnâ€™t include non-fixed costs such as utilities.
Your back-end DTI compares your income to the minimum payments on your outstanding credit accounts, including mortgage and non-mortgage debt. That means your back-end DTI includes:
Your back-end DTI is more commonly considered by lenders when you submit a loan application. A mortgage application will usually consider both your front- and back-end DTIs when deciding if you qualify.
Because a back-end DTI is more commonly used, assume that weâ€™re referring to this number unless otherwise noted.
Most lenders will also consider your DTI to decide if you can reasonably afford to take out and repay an additional debt. A low DTI tells them that you have room in your budget to take on and repay new debt, increasing your chances of getting approved for credit. But a high DTI could be a red flag to lenders that youâ€™re already stretching yourself thin and pose a larger lending risk.
If youâ€™re planning to apply for a home loan, car loan or other types of credit, itâ€™s important to figure out your debt-to-income ratio. Knowing your DTI will clarify whether youâ€™re likely to qualify for new credit, or if you need to take steps to compensate for a poor ratio.
Even if you arenâ€™t planning to take out a loan soon, maintaining a healthy DTI can be a good idea. Itâ€™s a sign that youâ€™re managing your finances well and avoiding taking on more debt than you can afford, and it will also make it easier to get a loan in an emergency or unexpected event.
As you take stock of your debt payments and income, you might be wondering how good a debt-to-income ratio needs to be. When lenders assess your loan application, what is a good DTI?
While DTI standards can vary by lender and product, some general rules can help you figure out where your ratio falls. Here are some guidelines about what is a good debt-to-income ratio:
Now that you know what is considered a good debt-to-income ratio, itâ€™s time to calculate your own. Hereâ€™s a step-by-step process to calculate your DTI.
If you follow these steps, you can calculate your DTI. Here it is as a mathematical formula:
(Sum of all monthly debt payments / Gross monthly income) * 100 = Your debt-to-income ratio
You can also use a calculator to automatically generate your DTI. We like the straightforward DTI calculator from our sister site Student Loan Hero, which generates both your front-end and back-end ratios.
After running the numbers on your debt-to-income ratio, you might be worried that yours is too high. Fortunately, you do have some control over your DTI and, with some time and effort, could decrease it.
The way to do that is to work on the two things that factor into this ratio: your income and your debt costs. Here are some ways you can work on each of these to improve your debt-to-income ratio.
Any new debt you accrue will only push your DTI higher. If youâ€™re already uncomfortable with how high your debt-to-income ratio is, thatâ€™s a sign that you need to stop borrowing until you get it under control.
Take a look at your budget to ensure youâ€™re living within your means and not spending more than youâ€™re making. If youâ€™re used to spending with credit cards, consider putting these away and paying only with debit cards or cash. Save up for major purchases or emergencies, too, so you can rely on your funds instead of borrowing to cover upcoming or surprise expenses.
Every time you pay off a debt completely, you eliminate the monthly payment from your budget. So making extra payments on some of your credit accounts could be a smart way to lower your monthly costs.
This can be especially effective if you follow the debt snowball method, which targets your lowest balance first to quickly eliminate your smallest debt. Each time you pay off a loan or credit card, youâ€™ll get rid of a monthly payment and lower your DTI in the process.
On top of decreasing your DTI, following the snowball repayment method will also get you out of debt faster and save you money that youâ€™d have otherwise spent on interest.
But if youâ€™re looking to get out of debt faster by reducing your total interest costs so that more of your monthly payments go toward the principal balance, you could opt for debt consolidation. With debt consolidation, you can take out a personal loan to pay off existing debts. The new loan should have a lower interest rate.
Debt consolidation could also help your DTI ratio by lowering your monthly payment. If you choose a longer repayment term, your monthly payments may decrease, which positively affects your DTI ratio. But a lower monthly payment may mean youâ€™ll be in debt longer.
If you want to explore debt consolidation loan options, you can try out LendingTreeâ€™s personal loan tool. Youâ€™ll fill out basic information about yourself, your finances and what you need out of a loan. Then you may receive loan offers from lenders you can review. Note that LendingTree owns MagnifyMoney.
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Another smart strategy to lower your monthly debt payments is refinancing. When you refinance debt, you use a new loan to pay off and replace a previous loan. Doing so gives you a chance to get a loan with terms, costs and payments that are a better fit for your needs.
Here are the main ways that refinancing student loans, a mortgage, credit cards or other debt can help lower your monthly debt costs and, in turn, your DTI.
You can refinance to a lower rate. Your monthly debt payments will include a payment to both your principal, as well as an interest charge. The former goes toward lowering your balance, while the latter is an additional cost you pay in exchange for borrowing these funds.
The interest costs are based on your interest rate. Refinancing can be an opportunity to replace a high-interest debt with a new, lower-interest loan. This, in turn, can help lower your monthly debt costs.
You can refinance to a longer loan term. Since refinancing means getting a new loan, it could also give you the chance to choose a longer loan term. This stretches out your debt repayment over more monthly payments, so you pay less each month.
Say, for instance, you bought a home with a 15-year mortgage but have found yourself uncomfortable with how high your monthly payments are. You could consider refinancing to a 30-year mortgage to decrease your mortgage payments and lower your DTI.
As you consider refinancing, watch out for potential downsides as well. Switching to a longer loan term will increase the total interest you pay over the life of the loan, and refinancing can also trigger new loan fees or closing costs. Weigh the benefits and drawbacks for your situation to see if refinancing makes sense.
While itâ€™s important to pay attention to your debt, donâ€™t overlook the other side of the DTI equation: your income. One of the most effective ways to lower your debt-to-income ratio is to increase how much you earn at your day job. Here are a few strategies that can make that happen:
Use your off-hours to earn more with a second job or side hustle. This can help you generate more income that can be included when calculating your DTI. As a bonus, this additional pay can be the perfect source of funds to pay your debt off faster.
Here are some side hustle ideas to consider:
If you canâ€™t or donâ€™t want to wait for your DTI to decrease to apply for a loan, you might still have options. Some mortgage lenders will grant you a loan with a debt-to-income ratio over 43% if you can compensate in other areas of your financial history. One way is by having large cash reserves on which you can fall back.
Applicants who can qualify on their own can also add a cosigner to their application. You and your cosigner will be equally responsible for repaying this debt, and both your incomes and DTIs will be considered as well. Adding a qualified cosigner could help you surpass DTI requirements that you couldnâ€™t meet on your own.
Lastly, you can work to optimize other factors considered on credit applications to improve your approval chances. Building your credit to achieve a good score, for example, can go a long way toward offsetting a higher debt-to-income ratio.
Your DTI is an important measure of your health that should matter to you as much as your credit score or reports. Check in on your debt-to-income ratio whenever it might have changed, such as after paying off a loan or working a side hustle for a few months. Tracking your progress can highlight how far youâ€™ve come and keep you motivated to continue working on your DTI.
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