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Debt to income ratio is one of the most important considerations in a person’s financial management. However, many people aren’t even aware of the term or concern themselves with working on it. The debt to income ratio tells you the percentage of your income that goes towards paying off our debt each month. This ratio is imperative to understanding your financial situation and knowing where you stand with your debt.
The debt to income ratio accounts for all your finances, including everything that you earn and save. Knowing about your debt to income ratio is essential because it impacts your overall financial standing, including the money you have in your accounts, your overall debt, and your credit score.
What is income to debt ratio, you ask? Well, it’s pretty simple and just what it sounds like. The income to debt ratio is the total amount of debt payments that you make each month divided by your gross monthly income. The income considered in debt to income ratio is usually the amount that you receive before tax cuttings and deductions.
Debt to income ratio, DTI for short, has a huge impact on your credit and ability to qualify for more debt. Lenders take your DTI into consideration while evaluating you as a borrower. The DTI is a good indicator of a person’s ability to manage debt payments. If you have a very high DTI, then the lender may hesitate from loaning you the funds as they wouldn’t be so sure if you have the capacity to make payments from within your current income.
Moreover, credit agencies take credit utilization into consideration as well; it is the amount of credit you utilize from what is available to you. Therefore, if your overall debt includes considerable credit card debt, it will have an impact on your debt to income ratio.
Take a look at the following example for further explanation and understanding:
Suppose your monthly debt payments include $2,000 for the mortgage, $150 for an auto loan, and $300 more for other loans, which makes the total monthly debt payments equal to $2,450. If you earn a gross income of $7,000 each month, then your debt to income ratio will be 34%. So, the lower your debt to income ratio is, the better.
Now, let’s learn all the tips and techniques that can help you lower your income to debt ratio and help you achieve financial stability.
Remember, don’t fall for a debt consolidation scam.
Tips for bringing down the DTI ratio
In order to cut down on your income to debt ratio, you’ll have to act with immense discipline, perseverance, and dedication. You can achieve your goals by taking the following actions:
Be smart about your finances.
The first thing you need to do is track your finances. Make a budget and stick to it. If you really want to lower your DTI, you’ll have to make some sacrifices of non-essential expenses. Focus on channeling that money into paying off your debt instead. The sooner you pay off your debt, the better it would be for your DTI and overall financial situation.
Therefore, instead of making unnecessary or non-essential purchases, make sure you put that money towards your debt payment. Moreover, it’s equally important to not take any more debt while you’re trying to lower your DTI. If you cut down on your expenses but take another loan, it will not help your DTI to decrease.
Consider Debt Consolidation
Debt consolidation is often recommended for debt management. If done right, it can help you reduce your debt to income ratio by allowing you to pay off your debt. This method is especially useful when your current income isn’t sufficient to help you bring down the DTI. You can consolidate all your loans into a single debt with lower interest and monthly payment. However, it doesn’t always work that way. If you don’t have a good credit score, the debt consolidation can end up costing more than your actual debt.
Therefore, research your options thoroughly and see if debt consolidation could benefit you in your particular financial situation. Only opt for consolidation of it comes with a lower interest rate and monthly payment. That way you can pay off your debt faster and slash your debt to income ration quicker.
Credit card debt is becoming an increasingly rampant problem for everyone worldwide, especially after the adverse impact that the COVID-19 pandemic has had on the economy, forcing many to need coronavirus credit card relief.
Prioritize one debt at a time
One of the best ways to manage debt and reduce your DTI is to focus your resources towards eliminating one debt at a time. When you take on the complete elimination of one debt at a time, it helps you reduce your DTI much quicker. On the contrary, when you’re trying to pay off all your debts equally, it reduces your rate of paying off the debt. For example, if you have taken eight different loans and you manage to pay off one of them entirely, then your DTI can go down by 12.5%.
Do not overspend
This may sound like obvious advice, but many people fail to live by it. You must limit your expenses, and that starts by working on your overspending habits. Even if you increase your income, it’s important to not waste your money on unnecessary expenses, but work on paying off your debt instead.
Don’t exhaust your emergency funds.
You may be tempted to tap into your emergency funds for your debt payments, but you must remember that their purpose is to serve yours during an extreme emergency. You can never know when a financial hardship can arrive, that is why it’s essential to have an emergency fund at all times.
Final Words
Taking actions to work on reducing your debt to income ratio is one of the most important steps you can take to improve your financial standing and to achieve stability. It doesn’t only reduce your debt but also improves your credit score and your overall financial management habits.
