Debt-to-income (DTI) ratio is one of the factors that determine your overall financial health. As the name implies, it’s the amount of your total monthly debt payments divided by your monthly income.
Lenders use your DTI ratio to assess your credit risk. Generally, they view those with higher DTI ratios as riskier since they may have difficulty repaying their debt in case of financial hardship.
The ideal DTI ratio depends on lenders’ standards and borrowers’ financial capabilities. But the rule of thumb is: the lower the DTI ratio, the better. Typically, a 35% or less DTI ratio is favorable. If your is higher than this, here are some tips to improve it.
Pay Off Debts
Chip away your big loans first—the higher your debt balance, the worse your DTI ratio. Hence, determine which dues have the highest balances and pay them off first. If you have spare cash, increasing the amount you pay monthly toward your debt and making advance payments can help reduce your overall debt and DTI ratio more quickly.
Reduce Interest on Loans
In addition to high balances, it also pays to lower the interest on your debt. It doesn’t only help you get closer to paying what you owe in full but lowers your DTI ratio as well. You can easily ask for a reduction in the rate from your lenders, especially those with whom you’ve been working for years. They’ll likely keep you as a client enough to reduce the rate.
Another way is through debt consolidation. Roll all your higher-interest balances into one personal loan with a lower and better interest rate. Say, if you have multiple credit card loans with rates around 15-17%, pay them off with the funds from a personal loan at 5%. It’ll help you pay your balances faster, save more money, and lower your DTI ratio more quickly.
With a strong credit score, you may also take advantage of credit cards offering 0% APR. They’re usually offered with a promotional period, typically between 6 – 24 months, after opening an account.
Use this 0% introductory offer by either paying off your outstanding debt or transferring your remaining credit card balances to the new credit card account. Since you’re not paying interest, you’re saving a lot of money as long as you fully pay the new credit card off before the promotional period ends. Plus, with each payment you make, your DTI ratio improves.
Avoid Taking on More Debt
Stop giving your money when you have remaining debts to pay off. Always reconsider using your credit cards on large non-essential purchases and applying for additional loans. Even if the lenders don’t require a pledged asset line or collateral, it’s crucial to reassess your financial situation first.
To get off the cycle of spending on credit, use a debit card or cash and stop using your credit cards unnecessarily. Remove any recurring bills automatically credited to your credit card accounts. If you want to go the extra mile, keep your overall credit limit high. It’ll make your credit utilization stay in a healthier range and, at the same time, lower your DTI ratio.
Follow 24-Hour Rule
If opting for your debit cards or cash doesn’t stop you from impulsively buying and taking on more debt, the problem could be managing yourself rather than your finances. There are several helpful ways to overcome emotional and unnecessary indulgence, and among the most popular is the 24-hour rule.
In finance, the 24-hour rule is the shorter way to say, “sleep on it before making any big financial decision.” For example, leaving a store selling discounted items and reconsidering the purchase for a day before spending. And if you’re still opting for your debit cards and cash, it’ll help you think twice about whether you’ll use it to purchase discounted items or pay for essentials. It can save you a lot of money and regret.
Do Side Hustles
Lastly, one logical step you can take to reduce your DTI ratio is to increase your income. You can achieve this by doing side hustles. The extra income you’ll earn can be used to pay off your remaining debts.
Understandably, you don’t want to take on yet another job, especially if you’re already working hard to get by. But you don’t have to do something you don’t like. Instead, do something fun and at the same time earn from it!
Take on side hustles you can enjoy. For example, if you’re a gamer, you can make money by streaming and playing video games online. You don’t need degrees or certificates for your hobbies to be profitable unless you want to be more professional.
It takes a lot of time and effort to improve your DTI ratio, but it’s worth it. The lower it is, the more financial resources you can access when you need them. More importantly, it gives you peace of mind knowing that you’re able to handle your finances responsibly.