What is debt-to-income ratio and why is this important?
Some people find themselves asking this question too late. Debt-to-Income Ratio, also known as DTI, is a measure of how much debt you have compared to your income. According to consumerfinance.gov, your DTI is one way lenders measure your ability to manage the payments you make every month to repay the money you have borrowed. To calculate your DTI ratio, simply divide your total recurring monthly debt by your gross monthly income (money you earn before taxes and deductions). Easy enough, right? Well, there are two types of debt-to-income ratios: front-end and back-end.
Front-end ratio (also known as mortgage-to-income ratio) is a ratio that indicates what portion of a person’s income is allocated to housing costs, including mortgage payments, HOA payments, insurance, and more. Back-end ratio, on the other hand, indicates what portion of a person’s monthly income goes towards paying all monthly expenses. This combines the mortgage, utilities, credit cards, child support, and any loan payments.
So, what is considered a good DTI ratio? Some loan products like qualified mortgages require mortgage lenders to make sure consumers have the ability to repay a loan by having a DTI ratio of 43% or lower. However, different lenders and loan products have different ratio requirements. A front-end ratio of 28% or below is usually pretty good, while a back-end ratio of under 36% is even better.
How to Improve Your Debt-to-Income Ratio:
Decrease your total debt: Make your loan payments and credit card payments on time and try paying a little extra on them to lower your balance faster.
Keep your debt to a minimum: When trying to improve your DTI ratio, avoid making larger purchases or taking on new loans during this time. New loans can sometimes increase your DTI ratio and even hurt your credit score.
Increase your income: Easier said than done, but if you increase the amount of money you bring in on a monthly basis without increasing your expenses, you can immensely improve your DTI ratio. So, get out there and find that part-time job, or better yet, push your side hustle!
Create a monthly budget: This helps to calculate your income and expenses. Be sure to include all your expenses, no matter the size (yes, even that $10 Spotify subscription charge). Organize your debt in a snowball fashion – from smallest to largest – and attack them systematically until they are paid off.
A financial coach during this time will increase your accountability. Remember, you did not get into debt overnight and it is a process to become debt-free. And most importantly, you are not alone!
Contact me today and set up a time to go over your plan and how to best execute it. The best plans are the ones we put into motion. My calendar link can be found at https://linktr.ee/Carlisacares.