Takeaways
- Your debt-to-income ratio measures your ability to service your debt.
- A low debt-to-income ratio makes borrowers more attractive to lenders.
- A high DTI can indicate a borrower has a high degree of personal leverage.
- Reducing debt and boosting income act as levers to your DTI.
- Try to improve your DTI before applying for a new loan.
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What is the Debt-To-Income Ratio?
Your debt-to-income ratio is the total monthly debt payments divided by your pre-tax monthly income. Your debt-to-income ratio gives lenders an express look at your financial health. It is a snapshot in time of how leveraged you are. The more debt you have relative to your income, the risker you are to lenders as a borrower. Some lenders create caps on your debt-to-income ratio as a screening mechanism.
However, if you have a low debt-to-income ratio, lenders know that your income can support debt payments. A low debt-to-income ratio can give you access to better lending terms, such as lower interest rates, higher principles, and lower fees.
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6 Steps to Boost Your DTI
If you are trying to get a new credit card, mortgage, auto loan, or personal loan sometime soon, it’s a smart money move to decrease your debt-to-income ratio ahead of your purchase. Here are six steps you can quickly take to lower your debts and increase your income.
1. Pay of Credit Card Debt
Credit card debt can sneak up on the unsuspecting consumer. If you have multiple credit cards with balances, you should focus on paying off your credit cards. Start by paying more than your minimum payments. Choose a debt repayment strategy, such as the debt snowball or the debt avalanche method.
Whatever method suits your needs, make a budget and set aside extra money to pay your credit card bills. Start paying off balances one by one until all your credit card debt is eradicated. Because credit cards charge such high interest rates, it is usually best to get rid of credit card debt first. Once you have paid off your credit cards, you can move on to other forms of debt.
2. Get Rid of Student Loans
No one likes paying back student loans, but millions of former students are burdened with high student loans that take decades to pay off. Don’t let your student loans hamper your ability to buy your first home or remodel your house. Get rid of student loans as fast as you can.
The first step to getting rid of student loans is to make paying off your student loans a short-term financial goal. Then focus on allocating as much of your monthly cash flow as possible to paying off your debts. You might need to cut expenses quickly and earn more income. Assign more discretionary income to pay off your student loans. As you do this, your debts will decrease, and you will have more money to pay off more student loans, thus creating a virtuous debt repayment cycle. If you do this consistently, you will finally be debt-free.
Get Started -> How to Pay off Student Loans Quickly
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3. Pay Off Your Car Note
New cars are depreciating assets. As a result, their value decreases substantially as soon as you drive off the car lot. If you are making payments on a new or used car, it’s time to buckle up and pay off your remaining auto loan.
For those who are ultra-dedicated to improving your debt-to-income ratio, you can even sell your car, eliminating the need for a car note. After you sell your new car, you can use your existing cash to buy a less expensive car. This might be a sacrifice you are willing to make if you are trying to buy your first home or improve your financial health.
4. Ask For a Raise
Do you already have your dream job? Then maybe all you need to do is ask for a raise or earn a promotion to get the extra cash you need to boost the income part of your debt-to-income ratio. Although increasing your salary might take more time than paying off debt, all you must do is start by seeing if your employer will pay you more for the work you are already doing.
If you feel like you are chronically underpaid, you are not alone. In a recent survey, 37% of people said they think their salary is barely keeping pace with inflation and that 41% are simply underpaid1. Oftentimes, the fastest way to get a bump in pay is to switch jobs. Accrue as much information as possible and then perform an extensive job search. Who knows, you might find a much higher-paying job, or your employer might offer you more income to stay.
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5. Start A Side Hustle
After you have exhausted ways to cut expenses from your monthly budget to increase your ability to pay down your monthly debts, you can turn to increasing your income. There are hundreds of ways to earn money in today’s economy.
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Whether that means starting your own business or making more income from driving for Uber or Lyft, babysitting, or taking surveys online, there are numerous ways to pad your pockets with extra cash. The key is to focus on one of your skills and use it to make extra income. For example, if you are a great writer, consider posting writing jobs on UpWork. The options are as endless as your imagination.
6. Invest Extra Cash
Optimizing your finances for extra cash flow can help you on your journey to improving your debt-to-income ratio. There might be apparent opportunities right in front of you. For example, if you have an emergency fund, slush fund, or project fund (e.g., down payment savings) sitting in an idle checking account, consider moving those funds to a high-yield savings account.
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As interest rates rise, so do the opportunities to earn high interest on your savings. For example, if you have $30,000 in savings for a down payment, you can put that cash into a high-yield savings account earning 4.3% APR and make roughly $962 in interest income. The only work required by you is to move your money into a high-yield savings account, which takes only a matter of minutes.
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Smart Summary
Improving your debt-to-income ratio can be done quickly and has positive financial consequences. Boosting your financial health by decreasing your monthly debts and increasing your income is a smart money move. It is uber smart if you are going to proactively enhance your debt-to-income before a major purchase like buying a house, purchasing a car, or renovating your house. Financial planning with save you thousands of dollars and leave you feeling prepared.
Frequently Asked Questions
Your debt-to-income ratio is a quick financial snapshot that lets your lender know whether you are a financially healthy borrower. Knowing how your DTI works can help you saving thousands of dollars of interest.
A Level 1 debt-to-income ratio is a terrific place to be for borrowers. This means your DTI is less than 20%, and you have plenty of discretionary income to service debt.
Even sophisticated banks, like Wells Fargo, agree that a Level 5 debt-to-income ratio is too high. If you have over 50% of your discretionary income servicing debt, you are in a poor position and should work diligently to reduce your debt and increase your income as fast as possible.
