Credit Cards

5 Tips to Lower Your Debt-to-Income Ratio

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Although it’s easy for a DTI to creep up, there are simple steps you can take to lower yours.

Key points

  • A high debt-to-income ratio can make it hard to get credit.
  • It’s possible to lower your debt-to-income ratio by adjusting the way you spend and pay off debt.

When it comes time to get a mortgage or open a new credit card, one of the first things a lender or creditor does is check your debt-to-income ratio (DTI). Generally, an acceptable ratio is 36%. Anything higher, and some lenders start to worry that you already have too much debt. Here, we offer five tips for reducing DTI to a healthier ratio.

What is the debt-to-income ratio?

DTI calculates how much you owe based on your income. It’s an easy way for a potential lender to figure out how much debt they’re already responsible for and whether they can afford to take on more.

How to calculate DTI

Calculating your DTI is simple. It’s a matter of adding up your monthly debts and dividing them by your monthly gross income (the amount you earn before taxes). As you add up your debts, include things like:

  • Mortgage or rent payments
  • Auto loan payments
  • Credit card payments
  • personal loan payments
  • Home Owners Association (HOA) dues, if paid monthly
  • Alimony or child support payments

You’ll notice that the payments you’re adding up are often associated with debts that will one day be paid off. Don’t include things like utility bills, charitable contributions, child care, or groceries.

Let’s say you earn $6,000 per month before taxes and your monthly debts total $2,500. To calculate your DTI, divide $2,500 by $6,000 ($2,500 รท $6,000 = 0.4166). The result is 41.6%, almost 6% higher than the “ideal”.

If you calculate your DTI and find it’s over 36%, or if you want to lower an already healthy DTI even further, here are five ways to do it:

5 ways to reduce DTI

1. Pay off high balances

The higher your debt balance, the higher your DTI. Take a look at all your debts and find out which one has the highest balance. Not only will lowering that balance get you closer to paying off the debt in question, but you’ll find your DTI goes down with each payment.

2. Lower debt interest

The lower your interest rate, the faster you can pay off the debt in full. There are several ways to lower your rate. The first is to call the lender and ask for a rate reduction. If you’ve been working with a particular financial institution for years, they know of your reputation for paying on time and may want to keep you as a customer long enough to lower your rate.

Or, you can consider consolidating higher-interest debt into a single personal loan with a lower interest rate. Let’s say you have three credit cards, each with an interest rate between 15% and 17%. If you can get a 5% personal loan and use the funds to pay off credit cards, you’ll save money, pay off your debt faster, and quickly reduce your DTI.

If your credit score is strong, you also have access to some great credit cards with 0% introductory offers. Here’s how these offers work: A credit card company offers 0% interest for a set period (usually 12-18 months) to new customers. Use the 0% offer to pay down outstanding debt or transfer outstanding credit card balances to the new card. You save money by not paying interest as long as you pay off the new credit card in full before the promotional period ends. Also, your DTI goes down with each payment.

3. Put credit cards on ice

Sometimes the best move is “stop”. Stop buying things because you want them instead of needing them. Stop giving money away when you have a debt you should be paying off. If you find yourself taking out a credit card for things you don’t need, consider freezing your credit cards. Some people have found that freezing their credit cards in a block of ice in their freezer gives them the time they need to talk themselves out of making unnecessary purchases.

4. Implement a ’24 hour rule’

The fact that there are so many proven ways to avoid spending money is a testament to how many people have had to find smart ways to control their finances. One of these methods is the 24-hour rule. Let’s say you’re at a furniture store with a friend and you see a buffet table that would look great in your dining room. It has been discounted multiple times and is calling his name.

It’s okay. You’re going to find a lot of things that appeal to you as you work to lower your DTI, and some of those things will be discounted. The 24-hour rule requires that you leave the store (without buying the buffet table) and think about shopping for a minimum of 24 hours before opening your wallet. Is it worth it for you to go deeper into debt? Are you willing to trade a lower DTI for a new buffet table?

And, if you’re thinking of paying cash, give yourself time to consider whether it would be better to use the money to pay off existing debt.

5. Take a hustle you can enjoy

No one wants to hear that they have to take another job, especially when they are already working hard to get ahead. But stay with us here for a moment. There are so many cool part-time hustles available today that it’s possible to find one that makes your heart sing a little. For example, if you play a musical instrument (you don’t have to be a professional), you can give lessons to a few kids a week. You can teach English to children in Asia. You can sell crafts that you usually give away. If you can find a way to earn money while doing something you enjoy, it’s win/win. Use those funds to pay down debt and reduce your DTI.

Lowering your DTI can take time and effort, but you’ll find that both are worth it. This is because a low DTI makes it more likely that you will have access to financial resources when you need them and can help you get a better night’s rest.

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