Why you should know your debt-to-income ratio
Today, roughly 300 million Americans are in some form of debt. However, not all debt is necessarily bad. After all, the ability to finance purchases such as a mortgage or car loan comes in handy for those of us with less liquid assets. While debt isn’t necessarily bad, there’s an integral number that you should know in order to understand how your income and your debts will affect your future purchases. This number is known as the debt-to-income ratio or DTI.
Why DTI is important?
Your debt-to-income ratio is a percentage factor that shows how much of your income is used for debt repayment. The higher DTI you have, the heavier the burden of debt is on your personal finances. Generally, a DTI of 36% or less is considered good. If your debt-to-income ratio is more than this number, you may have a hard time receiving financing. This is because credit card companies or other lenders believe you will be less likely to repay your debts if you’re already weighed down by too many payments. For mortgage lending specifically, a debt-to-income ratio of up to 43% will usually be accepted once you include your prospective mortgage payment into your monthly debt payments.
How to calculate your ratio
Your debt-to-income ratio is your monthly debt payments divided by your monthly gross income. The first step in calculating your DTI is to add up all your monthly debt payments. Be sure to include bills like car loans, student loans, credit card payments, mortgages, personal loan payments, or any other bills where you pay off debt. The next number you’ll be crunching is your monthly gross income. To find your monthly gross income, add up your paychecks, side income, investment income, or any other income you regularly receive. If you receive an annual bonus, it’d be best to leave this number out of your monthly gross income in order to get a more realistic picture of how much money you’re bringing in on a month-to-month basis.
Now, you’ll need to divide your total monthly debt number by your total monthly gross income number. Move the decimal point two digits over, and voila: you have your DTI percentage. If math isn’t necessarily your forte, there are several DTI calculators online that find this number for you.
Improving your DTI
Not happy with your debt-to-income ratio? Here are a few ways you can improve it. If you have some free time aside from your regular work schedule, try taking on a side job. Adding more regular income to your DTI will lower your percentage rate overall. If you’re strapped for time, an alternative way to improve your debt-to-income ratio is by paying off your debts. There are many debt pay-off strategies, and you should definitely take some time to evaluate which method will work best for you. In addition, creating a personal budget will help improve your DTI by showing you where your money is going every month. You may be overspending in certain categories, like food and entertainment, when that extra cash could be better used on debt payments. If you’ve already crunched the numbers on your monthly expenses, consider taking a good, hard look at your personal budget to see where you can cut costs and funnel money into debt.
Cutting your living expenses, for instance, may free up a few hundred dollars a month that could then be used for debt payoff. Try downsizing your living space, finding a roommate, or relocating to a cheaper area. Soon enough, you’ll repay some of your debts and your debt-to-income ratio will start to improve.