How to lower debt-to-income ratio - 6 Ways to do so
It is not possible to think of a life without debt. Being in debt helps us to enjoy a good lifestyle. However, your debt should be manageable. When it’s so, your debt-to-income (DTI) ratio should be within 28% and 36%.
That means you shouldn't spend more than 28% of your gross monthly income on housing expenses and not more than 36% on overall debt payments.
However, if your DTI is more than that, don’t worry. There are ways to lower debt-to-income ratio. Just follow certain tips discussed in this article.
How much is too much debt-to-income ratio
I can say that 1% more than the 28/36 rule should be too much for you. Rather, you should try to lower your DTI a bit more than 28/36; the lesser, the better.
As already stated, the 28/36 rule means that you shouldn’t use more than 28% of your total income towards the housing expenses, which includes mortgage payments along with insurance payments. And, you should spend within 36% of your gross monthly income towards your overall debt payments.
You can use the debt-to-income ratio calculator to know whether or not your DTI is within the range. You just have to give the required inputs to the debt ratio calculator and it will show the required percentage.
What debt-to-income ratio do banks look for?
If your DTI ratio is more than 50%, then definitely you are overburdened with debt.
However, the banks usually don’t accept loan request of a borrower whose back-end ratio* is more than 43%. It means that a person has enough debt load and he/she can’t handle more debt.*[Link to this page on “Types of DTI ratio”]
So, ideally, a DTI ratio within 36% is said to be a good one to manage more debt effectively.
Consequences of a high DTI ratio
Before talking about the ways to lower your debt-to-income ratio, know a bit about the consequences of a high DTI ratio.
- It will be difficult to take out loans, especially auto loans and mortgage.
- Difficulty to pay bills because most of your income is used to repay debt.
- It may hurt your credit score too.
How to lower debt-to-income ratio
Here are the 6 ways to lower DTI ratio.
1 Choose a good debt repayment strategy
Answer a question - What is the best way to reduce the debt load? It’s very simple. Pay them off.
So, choose a debt repayment strategy that you can follow to reduce debt.
This is a good way if you’re looking for how to quickly improve the debt-to-income ratio. It will give you somewhat instant results. This is something which you can figure out yourself. You won't have to wait for long to get it reflected on your credit report or score.
As you go on paying back debts, your DTI ratio starts improving.Debt repayment strategies you can opt for:
- Following the debt snowball and avalanche method - Make 2 lists of your debts, one from the lowest balance to the highest one and another one from the highest interest rate to the lowest.
- Select 2 debts - the one with the lowest balance and the other one with the highest interest rate. Now, make extra payments on these 2 debts while making minimum payments to others. As soon as you repay a debt, select the next one from the list. Doing so, not only you’ll be motivated, but it’s also better for your financial health.
- Consolidating debts - You can take out a low-interest balance transfer card and transfer your high-interest debts to the new one. However, make sure you repay the transferred balance within the validity of the low-interest period.
- Settling debts - By opting for this method, you can reduce your debt load by paying less than what you owe.
But, while you choose a strategy, make sure you plan a realistic budget which you can follow.
2 Cut your expenditure as much as possible
Do you think there’s no way to cut your spending? Evaluate again. There must be some way to do it unless you’re practicing frugal budgeting.
So, where would you try to reduce spending?
Check out if you’re eating out often. If so, switch to a healthy alternative by cooking meals at home, and in turn, save money too.
A good way to reduce spending is to do shopping with cash. It is proven that once you start paying with cash, you can’t pay more since you feel that money is going out.
3 Look for ways to increase your income
When was the last time you had a talk with your boss to raise your salary?
What you can do is you can talk to accept a more responsible position, and in turn, get an increment.
Also, do your homework. Do you have to undergo any training to go to the next level? If so, do that and make yourself competent to the next level.
Another way to increase your income is to use your leisure time and earn extra. You can look for part-time income opportunities online which you can do from home. This way, you can earn at the comfort of your home.
Now, whatever amount your increment is or the amount you’ll be able to earn extra, use it to reduce your debt load.
4 Reduce your grocery budget
What should be the average cost of food per month for 1 person? It is around $125 per person per month.
So, you can calculate the grocery budget for a family of 4 per month. It should be within $500.
Check out how much you’re spending now; if more, try to reduce your grocery budget.How will you do that? Here are a few tips to lower DTI ratio by lowering your grocery budget.
- Make a list before going grocery shopping.
- Plan your meals during the weekends.
- Arrange and use the discount store coupons if the items are on your grocery list.
- Take advantage of sales but only if you need the items available on discount.
- Use cash to buy the items unless you’re using a good rewards card.
- If buying in bulk, make sure you can consume the items before the expiry date.
5 Negotiate to reduce interest rates as much as you can
You can reduce the interest rates on your debts by negotiating with the creditors.
For example, if it’s becoming difficult to repay a credit card, you can explain your financial situation to your creditor and negotiate an alternative plan.
Likewise, if the interest rate on your mortgage is higher than the current market rate, you can refinance your existing loan with a new one.
6 Borrow from your retirement accounts if you want to repay fast
This should be your last resort to lower your debt-to-income ratio fast. Take out a loan from your retirement account.
However, if you withdraw from your retirement account, you usually would have to pay a penalty. And, make sure you pay back the amount as fast as possible.Some more tips to lower your debt-to-income ratio:
- Never make a large purchase with a credit card. Save the amount and then buy that item.
- Try to reduce your cable bill, eating out, etc.
- Make extra payments towards your debts every month.
- Do not take out a loan for the time being.
- Use store discount coupons and flyers while going shopping.
Do you have any more tips? Please share here…