How To Improve Debt-To-Income Ratio

Reducing your debt-to-income ratio improves your credit score and increases your chances of qualifying for a mortgage loan. It will also help you to snag a better interest rate on your mortgage. Fortunately, there are a variety of different ways to improve your debt-to-income ratio.

Figure Out Where You Spend Your Money

Track your spending for a week or two. In addition to making you more mindful of your spending, expense tracking will help you identify all the splurges that accumulate too much outflow.

Identify places where you can cut back (be realistic!), because you’ll need the extra money to reduce your existing debt payments.

Make A Plan To Reduce Existing Debt

Lowering your debt-to-income ratio number is all about reducing your existing debt. There are two popular methods to paying off debt:

• The Debt Snowball Method: Paying off your smallest debt first and working your way up to your largest.
• The Debt Avalanche Method: Pay off high-interest debts first.

Because debt-to-income calculates total monthly payment obligations, and most installment loans have fixed monthly amounts whether you pay extra or not (such as a car loan or student loan, for example), it may make sense to pay off the smallest debts first in order to get those recurring monthly payments “off the books.”

No matter which way you choose to tackle your debt the result is the same: paying off debt not only saves money on interest, but also lowers your DTI.

Avoid Adding New Debt

While you’re paying down your current debt, don’t take on any new debt. Even if you don’t use a new credit card, the fact that you’re applying for a new one will be a red flag to lenders.

There is one exception: the balance transfer offer. If you can qualify for a credit card with an extremely low (or even 0%) introductory rate, it might be worth applying and transferring your higher-interest balances to it.

The lower interest rate will enable you to pay off debt faster because most of your payment will go toward paying off the balance rather than paying interest. Keep in mind that to make this work from a DTI standpoint, you should formally close your other credit accounts and stick to your payoff plan.

Pay More Than The Minimum

Any time you owe a debt, if you can afford to pay more than the minimum it will help you chip away at the actual loan balance. By paying only the minimum, you are merely covering the interest on the loan and so your total debt doesn’t shrink. Additionally, paying more than the minimum helps to improve your credit score and minimize interest charges, too.

Find Ways To Make Debt Less Expensive

When paying off debt, the name of the game is making your debt as cheap as possible. If you’re carrying high-interest credit card debt, try to find less costly alternatives, such as:

• The balance transfer offer mentioned above.
• Asking your current card companies/debtors for a lower interest rate.
• If you already own a home, you might consider a cash-out refinance to consolidate debt.
• Applying for a personal loan with a fixed repayment schedule to consolidate debt to a lower interest rate.

How To Calculate Debt-To-Income Ratio

Your debt-to-income ratio is simple: it’s the sum of how much money is owed per month divided by the sum of how much is earned. Below is a step-by-step tutorial on how to do a quick calculation of your DTI.

Add Fixed Monthly Debts

The first step in calculating the debt-to-income ratio is adding up all your existing monthly debt obligations. These expenses may include:

• Student loan payment
• Existing rent or house payment (even as a renter you’re not “in debt,” but it is still an obligation you must pay each month!)
• Credit card payment
• Monthly car payment
• Monthly alimony or child support payments
• Wage garnishments or installment payments on back taxes.

Take how much you pay each month for each of these items and add them all together. This is how much you pay each month in debt.

Add Your Gross Income

To get to your total gross income we want to add up all our sources of income, and how much they come to monthly, before taxes come out. Sources of income can include:

• Wages
• Business profits
• Salaries
• Tips and bonuses
• Pension
• Social Security
• Child support and alimony

Divide and Convert Result To A Percentage

The final step in calculating debt-to-income ratio is dividing the gross monthly income number by the sum of the fixed monthly debt. Voila! This is your debt-to-income ratio.

Let’s work through an example.

• Assume you pay rent at a monthly rate of $1,000
• You also have a car payment of $400
• And a minimum credit card payment of $150

This is a total monthly debt amount of $1,550 per month.

• Let’s also assume you have a gross monthly income of $5,000.
• Your debt-to-income ratio is $1,550 divided by $5,000, which equals .31. Multiply this number by 100 to get a percentage (31%).

Lenders consider those with a lower DTI to present a lower credit risk. With a 31% DTI, not only will you more likely be preapproved, you’ll also likely qualify for a low interest rate.