Financial Watch | November 2022

Do You Know Your Debt-to-Income Ratio and Why It Matters?

What is DTI?

Your debt-to-income ratio (DTI) is used by lenders to help determine if you can make the monthly payments required to pay back a loan on time. Generally, the lower your ratio, the better. A DTI that is too high can result in lenders denying credit or reducing the amount they are willing to lend.

Maintaining a lower DTI can put you in a better position to borrow money when you need it and avoid overextending yourself by taking on more debt than you can comfortably afford. That begins with understanding how your DTI is calculated.

To calculate your DTI, add up all your monthly debt payments and divide them by your gross monthly income. Your gross monthly income is generally the amount of money you have earned before taxes and other deductions.^{For example, if you pay $1500 a month for your mortgage, $100 a month for an auto loan and $400 a month for the rest of your debts, such as student loans and credit card debt, that brings your monthly debt payments to $2,000.}

($1500 + $100 + $400 = $2,000.)

If your gross monthly income is $6,000, then your debt-to-income ratio is 33%.

($2,000 = 33% of $6,000.)¹

While lender requirements may differ depending on the size, purpose and type of loan, the lower your DTI, the less risky you appear to lenders. According to Experian, one of the nation’s major credit bureaus, a general rule of thumb is to keep your DTI below 43%. However, if you’re seeking to qualify for a mortgage loan, many lenders prefer ratios below 36%.²

7 ways to help lower your debt-to-income ratio

A low debt-to-income ratio can help you maintain the financial flexibility you need to pursue your goals at each stage of your life. If you’re looking for ways to lower your debt-to-income ratio and improve your overall financial health, consider the following:

1. Reduce existing debt by paying off credit cards and paying down any other loans.
   
   
2. If you can’t pay debt off all at once, increase the amount you pay monthly toward your debt. Extra payments can help lower your overall debt more quickly.
   
   
3. Review your budget to see if you can save more money to put toward servicing debt. If you don't have a budget, start one.
   
   
4. If your budget makes it hard to pay more than the minimum due each month, consider a debt consolidation loan to help reduce debt faster.
   
   
5. Avoid taking on new debt by postponing large, nonessential purchases.
   
   
6. Consider ways to increase income, such as asking for a raise or promotion, taking on a side job or finding a higher paying job.
   
   
7. Recalculate your debt-to-income ratio regularly to track your progress.

Remember, while you can’t control the direction of interest rates, you can control how you are using credit. If you have questions about strategies for managing debt, contact the office to schedule time to talk about your concerns.

^{1 “What is a debt-to-income ratio?” Consumer Protection Bureau, 8 June 2022. https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-to-income-ratio-en-1791/.
2 “Debt-to-Income Ratio.” Experian, https://www.experian.com/blogs/ask-experian/credit-education/debt-to-income-ratio/. Accessed 4 Nov. 2022.}

^{This information was written by KRW Creative Concepts, a non-affiliate of the Broker/Dealer.}