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Your debt-to-income ratio (DTI) measures how much you pay to service your debts relative to your income.
To lenders, it is an important indicator for whether you are a good prospect for a loan and a critical component of your PRO Index.
To you, it can be a measure of financial health by showing how much of your monthly income is going to servicing your debts, which is something you should keep at all times so you don’t end up taking on more debt than you can handle as a borrower.
It can also be an indicator for whether you might be ready for important financial decisions like buying a home, buying a new car, making a strategic investment, and so on.
Ideally, you want to maximize your gross monthly income and minimize the amount of money you spend on your debts, which is how you lower your DTI.
The lower your DTI, the more favorable your chances of getting, for example, a mortgage or any other type of loan, and possibly on better terms (such as a lower interest rate).
To calculate your DTI, take your total monthly debt payments and divide it by your total monthly income (gross, not pre-tax).
Alternatively, you can automatically calculate your DTI using the Harvest PRO Index.
On the debt side, only debts for which you still have nine or more months more of payments to make are included in the calculation of your DTI.
Expenses that are not related to any money you’ve borrowed are not factored into your DTI.
1. Lower the interest on some of your debts
For some of your debts, you can look into ways to reduce the amount of interest you’re paying on them.
For example, you can lower your interest rate on your credit card debts through a credit card balance transfer, which is something we discuss in another one of our articles.
Refinancing is also one of the best ways to lower your interest for qualifying borrowers on everything from personal loans, auto loans, student loans, and mortgages.
You may also be able to negotiate directly with your credit for a lower interest rate rather than switching creditors completely to refinance.
2. Extend the duration of your loans
Extending the duration of a loan can be a way to lower your monthly loan payments on the debt.
However, you may have to pay a higher interest rate to compensate.
You’ll also be leaving yourself vulnerable to a heavier debt burden should there be any shocks to your income.
3. Find a source of side income
Finding another stream of side income can be helpful in increasing your income (thereby lowering the DTI ratio) and fulfilling your debt obligations.
For example, you can find side income by driving for Uber, renting your spare room out on Airbnb - to name a few potential ways.
You can check out our comprehensive list of side hustles here.
4. Look into loan forgiveness
This isn’t typically an option for private loans (unless you count debt relief programs, which can harm your credit score).
For federal loans, however, loan forgiveness can be an option, especially for student loans.
Check out this list by FinAid on some ways in which you can receive some forgiveness for your federal loans.
5. Pay off high interest debt
Make a list of the debt payments that you make every month.
Which of your debts demand the highest monthly payment? Try to pay that debt off first to lower your DTI and credit utilization ratio. Alternatively, you can try to lower that payment by extending your repayment timeline. You can automatically determine which debt to pay off first and see the amount of interest savings you'll make by using a debt snowball calculator. In general, whenever you can afford to make more than the minimum payments, you are optimizing your DTI ratio.
6. Lower your monthly payment on a debt
You can do this by asking for a lower interest rate on a loan.
You can also reduce the amount you choose to pay back on your loan.
While this will cause you to pay more interest on your loan in the long run, temporarily lowering your DTI now may be a good strategy to get you better terms on a large loan. Compare the savings you receive from a lower DTI now to whatever cost you might incur from choosing to lower the repayment amount on another one of your loans before making a decision.
7. Control your non-essential spending
Avoid adding to any existing credit card debt by controlling your non-essential spending.
This is a great way to lower a high DTI in the long run as more of your credit card payments go to paying off your debt principal and not to interest.
8. Look into a debt consolidation loan (but be careful of impacts to credit scores)
A debt consolidation loan is a loan that you can take out to pay off a few loans that you currently have.
A debt consolidation primarily offers two benefits:
Keep in mind that debt consolidation loans may adversely impact your FICO credit score and live on your credit report.
Expenses are not included when calculating your DTI, which is why it might not be as useful of a financial health indicator as say your monthly cash-flow, which measures how much money goes into and out of your bank account. This cash flow measures the comprehensive look at your complete financial picture. Some debt, such as mortgages, typically qualify as a good debt which you are building for the future equity of your financial life so long as you can reasonably pay these debts each month.
If you have a low debt to income ratio, that means you are in good financial health.
It may also indicate that there is room in your finances to take opportunities that may financially benefit you in the long term.
Hence why lenders rely on DTI to judge your suitability for a loan.
A lower DTI can be beneficial in many ways if you’re considering taking on additional debt as part of an asset purchase. That’s because your DTI can determine the favorability of the terms at which lenders lend to you. Your DTI can also serve as a financial health indicator that should pay attention to at all times to ensure that you’re not taking on more debt than you can handle.
Do you want to lower your DTI so that you can borrow at a better rate of interest? Looking for ways to reduce a monthly debt payment? At Harvest, we know that every bit counts so if you need help lowering a monthly credit card payment by securing a lower rate of interest on your credit card, check out our comprehensive personal finance and debt management offerings to see if we can help.
Harvest helps increase the net worth of the 99% through artificial intelligence and financial automation. To date, Harvest has refunded over $2M in bank fees and interest charges to its members with the ultimate goal of increasing the net worth of everyday Americans by $1 trillion by 2030. Our platform starts with providing immediate relief through bank fee and interest charge refunds, orients a member's financial health with our proprietary PRO Index™, and keeps track of net worth over time aided by our suite of financial tools. Check out our 8-step guide on "How to Build Wealth from Nothing" to get started on increasing your net worth.
Disclaimer: Harvest is not providing financial advice. The content presented does not reflect the view of the Issuing Banks and is presented for general education and informational purposes only. Please consult with a qualified professional for financial advice.