Q: What is a debt-to-income ratio?
A: A debt-to-income (DTI) ratio is simply the percentage of an individual's debts taken against his monthly salary. It is measured by how much of your income is used to pay all your debts on a regular basis.
Q: How is this important?
A: For one, lenders consider this crucial because it determines your likelihood of making monthly payments to them. They also take this into consideration once you apply for credit. Aside from that, the percentage determines how much they are going to lend you. As much as possible, the creditors also want to make sure that the loans they grant to you are affordable, by keeping payments to a manageable amount based on your income.
Q: Is there a specific percentage that I should aim for?
A: The ideal percentage is at 36 percent of your income. Any rate below that is a good sign, as you wouldn't have any difficulties in dealing with creditors. If your ratio is a bit higher, say, at around 37% to 40%, you may start struggling with paying for your debts. Consider it a warning sign if your DTI ratio is more than 40%; help is needed to fix your current situation.
Q: How do I compute for my debt-to-income ratio?
A: To figure out how much exactly your DTI ratio is based on your monthly earnings and expenses, here's an illustration just to give you a clearer picture of how this works. For example, if your monthly salary is $2500:
($2500 * 0.36 = $900)
This means that the highest possible amount allotted for your debts per month is $900.
Q: How do I figure out how much is my percentage, based on my current income and expenses?
A: Pretty simple. First, try to figure out how much is your monthly gross income. Gross income refers to how much you are earning before taxes and other deductions. Next, make a list of all the debts that you're currently taking care of—mortgage payments, car loan, credit card bills, student loans, personal loans, and the like. Do not include your monthly expenses in the list, like grocery expenses and utility bills. Indicate how much you're paying for each item every month.
Add up everything that you're currently paying for, and divide the total to your current monthly income.
For example:
Monthly gross income $2500
Total amount of monthly payables $ 675
($675 / $2500 = 0.27, or 27%)
This means that this customer has a very good debt-to-income ratio, because she falls way below the expected percentage. Future lenders will have confidence in her ability to make regular monthly payments to her bills, because she has enough resources to take care of them.
Q: Okay, that sounds good, but I don't exactly have the same situation. How do I fix my debt-to-income ratio?
A: There are two ways to repair a high DTI ratio. First is to increase your monthly income. If it's possible, you may opt to ask for a raise from your current employer. Or, you may choose to sell some stuff, or take a part-time job. Having another job may sound taxing at first, but keep in mind that it only will be a short-term solution, not just to improving your DTI ratio, but for your financial situation.
Another option is to lower your living expenses. There are many ways of doing this: you can reduce unnecessary food expenses by bringing a packed lunch to work. You can walk instead of drive—that is, of course, if your destination is nearby. The most feasible and practical way of lowering expenses is by creating a budget. This way, you are able to keep track of where your money goes each month. A budget also creates a more organized way of spending. It also allows you to set limits for yourself and not just excessively overspend.
Want to speak with someone about how you can improve your debt to income ratio? Submit a form now and one of consultants will give you a free consultation about your debt relief options!
Or read these related articles:
How to calculate your debt to income ratio
How does a debt to income ratio work?