If one of your goals in life is to buy a home, you’ll want to learn more about your debt-to-income ratio (DTI) as it will allow you to determine how suitable you are to take out a loan. Learning the ins and outs of personal finance is a large part of understanding the home buying process, and how to best position yourself for success by controlling the factors you can, and educating yourself about the ones that you simply can’t. Since DTI is an important part of the borrowing process, you’ll want to be aware of what that ratio is when you apply for a mortgage.
Debt-To-Income Ratio: A Definition
If you’re not familiar with what debt-to-income ratio is, it compares how much money you’re spending on debt repayment versus your gross monthly income. When it comes to buying a home, lenders will often use this to determine how much debt related to your home you can handle in addition to other debt you may have.
Why Is Your Debt-To-Income Ratio Important?
Knowing your DTI is important, even if you aren’t in the market for a new home. Seeing firsthand how you manage your own finances every month will give you a chance to really analyze where your money goes and may help you make smarter financial decisions in the short and long term. More often than not, being face-to-face with our debt can be a serious wake up call. Stay informed and pay attention to your management of money so you can not only position yourself for success in the future, but also make wiser decisions in the short term.
How To Calculate Your Debt-To-Income Ratio
Now that you know what your debt-to-income ratio is, it’s important that you know how to calculate it and understand the number you come up with as a result.
DTI = (Total monthly debt, including mortgage, car loan, credit cards, etc. / Monthly gross income)
For example, if you make $5,000 each month and that debt includes a $1,500 mortgage payment and $400 car payment, you will get a number of 0.38 which you then convert into a percentage to get the debt-to-income ratio of 38%.
The calculation is fairly simple, but the power comes in understanding the data; how do you know if your DTI is good or bad? While the number can be subjective depending on your wages and the type of debt you’re carrying, there are a few general rules that will help you understand where you fall on the scale.
Generally speaking, if your DTI is over 50%, you have far too much debt for your income. The highest DTI you can have while still qualifying for a mortgage is usually in the low 40s and will depend on who your lender is, so it’s wise to ask questions about that in advance if you’re concerned. Having a DTI in the mid- to low 30s is ideal. Anything lower than that is difficult to achieve if you have a car payment or mortgage, so don’t be too hard on yourself if your number seems higher than expected.
At the end of the day, the lower your DTI, the better chance you have of securing a mortgage or any type of loan you may need.
Ways To Lower Your Debt-To-Income Ratio
If you’ve just calculated your DTI, you may find yourself stressing out if the results revealed a less-than-ideal number. Luckily, there are a few ways you can actively work to improve your debt-to-income ratio if you’re concerned.
Debt Payoff
Simply put, the more money you put toward your debt, the faster it disappears. Instead of opting for the minimum payment every month, if you have the extra cash, put down a larger chunk of money to help bring down your debt faster. This suggestion is only relevant if you have the extra income to push into debt payoff or can stand to trim other areas for the sake of paying down your debt faster.
Increase Down Payment When Borrowing
The more money you put toward your down payment, the less money you’ll need to borrow from the bank to buy a house. Take the extra time to save up more cash for a down payment as it will get you access to better rates and options down the road when you’re ready to buy.
Consolidate Debt
If you have multiple sources of debt with high interest rates, you may want to consider consolidating them all into one lump sum to get access to a much lower interest rate and an easier repayment structure. You can apply for a debt consolidation loan which is an unsecured personal loan that you can use to pay off debt. You won’t need to provide any collateral and you will qualify solely based on your credit score. Do your research to discover the pros and cons of this option as there is a lot to consider before taking on a personal loan.
Lower Your Credit Card Usage
Using credit cards regularly is one of the main sources of debt, and it’s often avoidable. Give yourself a cash budget weekly or make it a point to track your spending by saving receipts so you can see where your money is going and only spend what you have on hand instead of relying on credit. If you have multiple credit cards, you may consider getting rid of a few to reduce your ability to spend money you don’t actually have. The less you charge on credit, the lower your debt, the better your DTI.
Get A Raise Or Promotion At Work
Increasing your income is one of the best ways to improve your DTI. Before you go hunting for a new job, consider approaching your current boss for a raise and stating your case in regard to why you deserve a pay increase. Interestingly enough, most people have never asked or feel intimidated at the thought of asking for a raise. They’re worried they’ll sound greedy, so instead they wait for their employer to notice their work and take action on their behalf, which is far less likely.
If you want to ask for a raise but aren’t sure how, these five tips may help:
1. Know that it’s normal to ask. There’s no need to be ashamed or stressed out, so shake off your nerves because your boss has likely dealt with tons of people asking for raises in the past.
2. Be thoughtful about when you ask as your boss is human and may be having a bad day or dealing with a stressful issue that could leave them in the wrong mindset.
3. Know your company’s raise and budget cycles so you know when it’s best to ask.
4. Understand what your work is worth and do some industry research online.
5. Have a plan for how to respond if the answer is “no” or “maybe.”
Start A Side Hustle
If you want to work on raising your income, but approaching your boss about a raise just isn’t a possibility, consider starting a side hustle to bring in extra income. If you’re not sure where to begin, make a list of things you’re good at and then work on how to monetize one so you can bring in some extra cash doing something you enjoy. You can also take on a side job through another company or seek out income in other ways.
If you’re looking for inspiration, consider these popular side hustle options:
- Sign up to be a delivery person for a grocery delivery app
- Apply to be a driver for a ridesharing app
- Start a blog based on your knowledge
- Get into tutoring
- Look into online freelancing if you have applicable skills
- Buy and resell items online
Knowing your debt-to-income ratio is only half the battle. Once you’ve calculated your number, know that it isn’t final, and you can work to improve it if you’re concerned. It’s empowering to understand the data behind how and why you qualify for a loan. It can help you make smarter financial decisions and give you a leg up when you’re discussing options with a lender. If you’re in the market for a new home, our team can help. Reach out to learn more about the home buying process and how to prepare for what will likely be the biggest financial transaction in your lifetime.