In addition to your credit score, your Debt-to-Income (DTI) ratio is an integral part of your financial health. Calculating your DTI ratio may help you determine how comfortable you are with your debt and decide which credit cards are best for you. When you apply for credit, creditors and lenders evaluate your DTI to determine the risk associated with you taking on another line of credit.
As always, you must not let your debt get out of control. Too much debt can have negative consequences. If you find yourself with more debt than you can handle, contact the debt attorneys at McCarthy Law.
3 Steps to Calculate Your Debt-to-Income Ratio
Your debt-to-income ratio compares how much you owe each month to how much you earn. More specifically, it is the percentage of your gross monthly income that goes toward your debt. Follow these three steps to calculate your DTI ratio.
- Add up monthly bills: The first step to find your DTI is to add up all your monthly bills, including student loan payments, auto loan payments, credit card bills, and mortgages. It’s important to note that expenses like groceries, utilities, and fuel are generally not part of your monthly debt expenses.
- Determine your monthly income: You will then need to determine your gross monthly income. This includes all income sources, such as second jobs, overtime pay, and bonuses. Salaried employees can divide their annual income by 12. If you are hourly or your pay fluctuates, review recent pay stubs to determine your monthly income.
- Divide monthly debts by your monthly income: Once you calculate how much debt you pay each month, divide that amount by your gross monthly income. It will give you a decimal figure, which you then multiply by 100.
What Is a Good Debt-to-Income Ratio?
Once you determine your ratio, you might be wondering if it is good. While DTI standards will vary by lender, some general guidelines can help you figure out where your ratio falls.
- 36% or less: Common financial advice states the 28/36 Rule. The guideline suggests keeping your monthly debt costs at or below 36% of your monthly income. Housing costs should be at or below 28%. A DTI in this range may result in more affordable debt and give you the ability to qualify for more credit.
- 37%-43%: 43% is typically the threshold for obtaining a new loan, according to the Consumer Financial Protection Bureau. You must take the necessary steps to remain in this range or fall into the 36% or less category.
- 44% and higher: Those with a DTI ratio of 44% or higher are must less likely to be approved for a loan. Borrowers with a higher DTI are more likely to struggle with paying their monthly debts, posing a risk to lenders.
Overall, the lower your debt-to-income ratio, the better.
How to Improve a Debt-to-Income Ratio
If you find that your DTI ratio is too high, there are several ways to lower it. One of the most straightforward ways is to pay off low balances first. Every time you pay off a debt, you eliminate the monthly payment from your budget. Making extra payments on your credit accounts is a smart way to lower your monthly costs.
Another way to lower your DTI ratio is to avoid taking on more debt. If you are uncomfortable with how high your ratio is, it might be a sign that you need to stop borrowing until you get it under control. Examine your budget to ensure you are living within your means and not spending more than you make. If you use credit cards too much, consider only using a debit card or cash. The less debt you take on, the better chance you have at lowering your DTI ratio.
Speak to the Debt Attorneys at McCarthy Law
Having a high debt-to-income ratio may have adverse effects on your life. No matter how hard you try, you might still be struggling with debt. When this happens, contact the debt settlement attorneys at McCarthy Law. Our team is passionate about helping clients navigate complex financial situations. We understand the burden debt causes and will do everything to secure a favorable settlement. To schedule a free consultation, call (855) 976-5777 or complete our contact form today.