What is Debt to Income Ratio and Why Does it Matter?
Your debt to income (DTI) ratio compares your monthly debt expenses to your monthly income. This evaluates how much debt you have, and your ability to repay those debts with your income.
How to Calculate your Debt to Income Ratio
To calculate your debt to income ratio, you must add up all of your monthly debt obligations. This includes credit card payments, car loans, and housing expenses. Then, you will divide your total monthly debt obligation by your monthly gross income. Gross income is income earned before taxes and other deductions.
What is a Good Debt to Income Ratio?
The Consumer Financial Protection Bureau states that borrowers’ DTI should not exceed 43% when obtaining a mortgage. Typically, mortgage lenders prefer to see borrowers with a DTI ratio less than 36%. Although, if your debt to income ratio is higher than anticipated, there are some steps you can take to lower your DTI.
How to Improve your Debt to Income Ratio
If your ratio is higher than 43%, here are some helpful tips to help you meet your goal!
- Increase the amount you pay towards your monthly debt obligations. Try to cut back on some unnecessary expenses and pay down any loan or credit card balance instead. These extra payments may seem minor in the moment, but any extra payment has a positive effect on your DTI ratio.
- Avoid taking on more debt. Reduce the amount of spending on your credit cards and postpone applying for more loans.
- Review your debt to income ratio monthly. Watching it decrease each month may be a great motivator to keep working towards your goal.
Improving your debt to income ratio may take some time. It’s helpful to create a strategy for yourself, such as the “avalanche” or “snowball” strategy, to help you stay focused and on-track. The “avalanche” strategy focuses on paying off your debts with the highest interest rates. On the contrary, the “snowball” strategy focuses on paying off your smallest debt first, and then moving onto the next debt.
If you’re interested in lowering your DTI, get in touch with one of our mortgage specialists to see how they can help you through lowering your debt to income ratio.