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What the Heck is Debt-To-Income Ratio?

Jun 12, 2019 - Posted by: Rocky Mountain Credit Union

Have you ever heard that your debt-to-income ratio is too high or seen it as an area of concern on your credit report? What you owe, what you make, and what payments go out each month all figure in to this magic number that is a part of your financial health. It helps in understanding whether or not you can afford that new payment, or if your credit is on the path of being maxed out. Okay, but why is it so important to know? Here’s everything you need to know about that all-important number.

Why You Should Care About Your Number

When you’re looking to borrow money for things like a new car or a home mortgage, your number is one of the factors that lenders consider, along with your credit score, to figure out how you’ll be able to handle another monthly payment.

The Consumer Financial Protection Bureau cites 43% or lower as the magic number that lenders love to see. That means that your ability to pay off your debt is likely pretty good, making it the highest number you can typically have and still get a Qualified Mortgage. However, 35% or lower is the cutoff for what is generally viewed as favorable. Even if you’re not looking to buy a house right this minute, it’s still a good idea to think about your ratio now so you can have more options down the road.

How to Calculate It

This is the simplest part: add up all your monthly debt payments (things like an existing mortgage, car payment, student loans, credit card debt) and divide it by your gross monthly income. And...that’s it! That’s your debt-to-income ratio.

How to Improve It

Some of these may seem simple, but there’s no cutting corners when it comes to improving your debt-to-income ratio.  

Increase Your Debt Payments 

Okay, this one might be a little on the nose, but increasing your debt payments is probably the easiest way to improve your debt-to-income ratio. As Dave Ramsey calls it, the debt snowball can help you drive down one debt at a time by focusing specifically on that one debt until it’s gone. It may seem easier said than done, here is the way he suggests to go about it.

First off, try putting even $5 or $10 more each month toward your smallest debt to help whittle it down a little faster. Then as you start to pay off debts, apply all the money that you had previously allocated to those smaller debts, and put them straight to the next largest. Finally, don’t add to your debt with big purchases before you’ve calculated how it will affect your debt-to-income ratio.

Seek Out a Side Hustle to Increase Your Income

Affecting the other half of the ratio can seem harder. After all, you make as much money as you make. You might be able increase your earnings by asking for a raise, but that is not always a winning strategy. How about taking on another job? Even one or two weekends a month can make a significant dent in your debt.  Maybe you don’t have the time to add on extra hours of work; you can look into things like selling items online or taking surveys while you watch TV to increase your monthly earnings. Today’s digital and E-commerce society has a variety of ways to impact your bottom line that don’t require you to spend your full time to make a profit.

Check In on It Regularly to See How It's Going

If you’re doing all this work to improve your debt-to-income ratio, you don’t want to just set it and forget it. Be sure to check in and recalculate it each month. After all, your financial health is well worth checking up on! There are also a number of financial apps to help you keep it in check.

To help get a better handle on your financial health, check out the financial planning offerings at RMCU. We are happy to serve you and help your money work better for you!

 

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