Debt-to-Income Ratio: How to Calculate

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Personal finance knowledge is very important if you want to lead a good financial life. But, as a whole, personal finance is a very broad niche and it is almost impossible for a person to know everything about it. However, there are certain things that are critical and everyone can learn. One of these things is the debt-to-income ratio.

The debt-to-income ratio is indispensable to the borrowing process. It also provides information about your financial standing in life.

What Is the Debt-to-Income Ratio?

So, what is the debt-to-income ratio exactly? In simple words, it is a personal finance calculation that compares a person’s debt with his income every month. This is very integral to know as the lender often sees this ratio before making any decision of borrowing. So, a better or excellent ratio means better chances of getting approved for the loan. A lender only trusts those who have a better debt-to-income ratio.

Not only this, knowing your own DTI ratio is important for several financial reasons. One reason is that it assists you in managing and handling your debt every month. Without a DTI ratio, it is impossible for one to have a better track of its debt and spending habits. This ratio gives a wake-up call every month to you if you have much debt as compared to your income.

Calculate Your Debt-to-Income Ratio Step-by-Step

Once you know what the debt-to-income ratio is, it’s time to learn the way to calculate it. Fortunately, the process is simple and fairly easy to learn. A debt-to-income ratio is calculated by dividing the debt payments by the money you make every month. The result is often presented in percentage.

For instance, if you make $5,000 every month and your debt is $1,000 every month, you will have a debt to income ratio of 20%. The calculation we did was 1000 divided by 5000 and then multiplied by 100. After turning the number into a percentage, we got 20%.

If this DTI ratio is low, it means you are performing well in life and there is no problem at all even if an emergency arises. However, if the DTI ratio is high or above 60, it means you are carrying much on your back. Thus, a high DTI ratio makes it hard for you to pay bills every month with so much of your income going to your debt payments.

What is a Good DTI?

What constitutes a healthy DTI varies based on your earnings and the sort of debt you have, but there are certain general rules and standards that you can follow. In general, if your debt-to-income ratio exceeds 50%, you have way too much debt for your income.

The greatest credit score you may have while still qualifying for a mortgage is in the low 40s, though this varies depending on who you borrow from. If you have a car payment or a mortgage, a DTI ratio in the mid to low thirties is desirable, and anything lower than that is difficult to accomplish. Simply said, the lower the score, the better off you’ll be and the better chance you’ll have of getting a mortgage, auto loan, or any other form of a loan.

Improve Your DTI Ratio

You’re probably in one of two camps now that you know how to determine your DTI ratio. Either you have a low or controllable DTI ratio and are happy with yourself, or you have a high DTI ratio and are beginning to worry and stress. In either case, there’s no need to be concerned because lowering your DTI ratio is a really simple process.

In general, there are three strategies to lower and enhance your debt-to-income ratio: remove or reduce monthly recurring debt, boost monthly income, or a combination of the two. While this sounds simple and straightforward, it is not always straightforward to increase your income or reduce your debt. You must adopt particular lifestyle modifications and remain aware of these issues in the future.

In theory, it’s simple, especially when compared to improving your credit score, which can take time and be unpredictable. Most people, however, will need to make significant lifestyle adjustments.

Useful Tips to Improve Your DTI

We’ve decided to provide a few specific ideas regarding things you may do to enhance your income and lessen your debts to make things a little easier for you. As previously stated, it’s all about paying off debts and increasing income, but that’s a rather wide definition, so here are some real-life examples to get you started.

Rent your space or your belongings

Renting out a room or an area of your home is one of the finest strategies to help lower your DTI ratio if you own a property. One of the most prevalent reasons for a high DTI ratio is that this might potentially cover most, if not all, of your mortgage payment. It would effectively be a reduction in your mortgage payment, which is always beneficial. You might also rent out objects or stuff you own to make some extra money.

Get a second job

One of the most effective strategies to reduce your DTI ratio is to increase your income. Of course, the first thing you should do is ask for a raise from your manager. If they refuse, you can either hunt for higher-paying employment or take on a part-time job to boost your income.

Pay Off Your Debts More Effortlessly

Of course, the more you contribute to your debt, the faster it will be paid off and the less time you will be in debt. Rather than paying the bare minimum or the same old monthly payment even if you can afford more, you should try to pay them off as quickly as possible. While this isn’t always easy, particularly if you have a low income, it can help you lower your DTI ratio quickly.

Examine Your Expenses in Depth

Many of us have a large number of monthly expenses, such as Netflix, a music streaming service, cable, and so on. While some of these are necessary, others are certainly not. If you rarely utilize a subscription or service, consider canceling it and putting the money toward debt repayment or increasing your savings.

Consider selling your car and replacing it with one that is less expensive.

A car loan payment, in addition to a mortgage payment, is one of the most significant drivers to a high DTI ratio. Instead of continuing to pay a car loan, you may not be able to afford, consider selling your automobile and replacing it with something less expensive. This would most certainly cut your monthly auto payment, lowering your debt-to-income ratio rapidly and simply.

The Bottom Line

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