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If you have ever applied for an auto loan, personal loan, or mortgage loan and were denied, it’s possible your debt-to-income ratio could be the reason you are having a hard time getting approved. What is a debt-to-income ratio, or DTI? It’s all of your monthly debt payments divided by your gross monthly income, often expressed as a percentage, and is the way lenders can measure how well you can manage the payments you make each month to repay the money you have borrowed. Your DTI will be looked at closely by lenders before your application is approved. High ratios are a red flag that you may not be able to pay back the money that you owe.
In order to calculate your DTI, add up all of your monthly debt payments, and divide them by your gross income, which is the money you have earned before any taxes and other deductions have been taken out. For example, if you pay $1,000 in rent, $250 a month for your auto loan, and $500 a month in credit cards (only the minimum payment is calculated), your monthly debt payments are $1,750. If your monthly gross income is $3,000, then your debt-to-income ratio is 58%. The Consumer Financial Protection Bureau, or CFPB, says consumers should have a DTI of 43% or less to take out a mortgage. Other lenders may look for a DTI less than 43% in order to approve you for other types of loans.
If your DTI is higher than that, you will need to focus on reducing your debt or increasing your income. Here are six tips that can help you lower your ratio to a more acceptable range:
You don’t have to stay on the repayment plan of paying a debt off each month over the span of several years. Make extra payments each month if it fits your budget in order to pay off your debt ahead of schedule. A good idea is to try paying off your debt with the highest interest first.
This strategy focuses on targeting the debts which reduce your DTI the most for the least amount of cash paid. For example, if you have card A with a $100 balance and a monthly payment of $20, and you have card B with a $50 balance and a $25 monthly payment, you should target card B first since your monthly payment is 50% of the balance. This will have a larger impact on your DTI.
Increasing your income is another way to reduce your DTI. You could try changing jobs if you receive a better offer, or you can ask your employer for a raise. You can start by taking on additional responsibilities and making sure to be on your A-game. When the time comes, ask your employer to reward your hard work with more money! Again, if you don’t get the answer you’re looking for, it may be time to change jobs.
If you pick up a side gig, it may take away some of your free time, but it will definitely help you get closer to a debt-free life. The extra income can help reduce your DTI, or even help you pay off your debt faster.
If you transfer your balances onto a credit card that offers 0% interest for a promotional period, it can help you pay off the balance faster. Keep in mind that there are usually balance transfer fees associated with this and that you should make sure you can pay off the entire debt before the promotional period ends.
Restructure your debt by refinancing loans, which can be a great option to lower interest rates and change your repayment terms. If in the process you are able to lower your monthly payments, you will positively affect your DTI.
By following these tips, you can help lower your debt-to-income ratio and finally qualify for that loan you’ve been applying for! Remember, once you’ve reached your goal, do your best to maintain your DTI under 43%. Learn more on how you can lower your DTI by checking out this video on the Keeping It Real With Credit YouTube channel:Watch Video