Three Creative Ways to Lower Your Debt-to-Income Ratio
Updated: Feb 28, 2019
Managing your debt is crucial to remaining financially healthy. If you are having difficulties qualifying for a personal loan, your debt-to-income ratio (DTI) may be the key issue. Lenders pay very close attention to your DTI to determine if you can afford regular monthly payments before approving a loan and to see how much of a risk you are. Fortunately, there is a way to find out if your debt is excessive, and ways to lower it to make your financial status more attractive.
What is Debt-to-Income Ratio (DTI)?
Debt-to-income ratio (DTI) is a financial tool used to compare your monthly debt expenses to your monthly gross income. It is calculated by adding up all your recurring monthly debt (for e.g., credit card payments, mortgage, and car loans) and household expenses, and dividing it by your gross monthly income. The result, which is expressed as a percentage, represents the amount of your income that goes towards paying a debt.
Why is DTI important?
DTI indicates to lenders how financially stable you are and is a major factor in how likely you are to receive a loan. The DTI allows lenders to set lending limits to clients with the intention of not causing a financial burden to the client. The preferred DTI differs from lender to lender; however, the maximum is generally 36%. If you notice your DTI is above that percentage, there are a few steps you can take to reduce it.
Pay off debt ahead of schedule
If there is room in your budget, increase the amount you pay on each installment so that your debt can be eliminated faster. You can use one of two methods speed up the payoff process:
Debt Avalanche Method: allocating excess funds to the debt with the highest interest rate, while making the minimum payment on your other debts.
Snowball Method: repaying the smallest to the largest loan balances. Create a list of all your debt and use excess funds to pay off the smaller balances, while paying the minimum installments on larger loans.
Increasing the monthly amount you pay under either strategy may increase your DTI temporarily. However, your DTI should fall to below the previous percentage (and stay there) once you’ve implemented one of the methods.
Note: Avoid taking on more debt unless it is a consolidation loan to pay off your other high-interest debt.
TIP: Regions Financial Services provides debt consolidation loans of up to $500,000 with interest rates as low as 0.9% weekly.
Increase your income
Effective ways to increase your income include negotiating a salary raise with your employer, working overtime, starting a side business and taking on a part-time job. The more you earn, the lower your DTI. You could also use the additional income to pay off your loan balances ahead of schedule. Although working longer hours or another job will require more time and energy, it will bring you closer to a debt-free life.
Previous DTI: 40000 / 90000 = 44%
DTI after income increase: 40000 / 110000 = 36%
Reduce spending/postpone large purchases
Review your budget to see the areas where you are spending too much money. For example, eating out a lot or purchasing the latest devices. You may see many areas where you can save money and apply those extra funds toward debt payments. Also, consider using cash where possible instead of credit cards so that your debt stops accumulating. It is more difficult to make an unnecessary purchase when you can physically see the amount of cash you are using.
Additionally, if you decide to make a big purchase such as a television or motor vehicle, you may need to reconsider that until your DTI has been reduced to a reasonable percentage. Postponing large purchases means you are using less credit, which allows you to save and make a larger down payment when your finances are in better shape. Also, you will not have to fund most of the purchase with credit, which may keep your DTI low.
Maintaining a low DTI will ensure that you can afford debt payments and gives you peace of mind knowing that your finances are in order. It is a big decision-maker for lenders, as a low DTI increases your chance of being qualified for a loan. Once you have evaluated your finances, evaluate your lending options to see which one has the best rates and terms for you. If you need help determining the ideal DTI for you, seek assistance from a financial advisor.
TIP: Regions Financial Services provides sound financial consultation, free of cost, on money management strategies and ways to achieve your financial goals.