Do you know your DTI? This lesser-known financial stat may not get the same attention as emergency funds and credit scores in the financial world, but it’s an important part of your financial story.
Standing for debt-to-income, your DTI is a ratio that provides enormous insights into your financial situation. To find out what they are, keep scrolling. Below, you’ll find out what DTI means, why it’s important, and how to calculate it.
What Does Debt-to-Income Ratio Mean?
The debt-to-income ratio is a financial metric that compares how much you owe in a month compared to how much you make. More precisely, it shows your monthly debt spending as a percentage of your income, so you know how much of your monthly paycheck goes to personal loans and lines of credit.
This simple ratio provides a quick snapshot of your overall financial health. After all, the higher your percentage is, the more of your paycheck is tied up by debt.
How Do You Find Out Your DTI?
Calculating your DTI is easy. All you have to do is round up all your debt accounts and figure out their monthly payments. Add these payments together. This represents your total expenditures on all loans, including mortgages, credit cards, installment loans, and lines of credit.
Next, determine your monthly income before taxes and other deductibles. Remember to include all that you earn a month. This might include your basic wages, as well as commissions, tips, child support, etc.
Now it’s time to do a little arithmetic. Take your total debt obligations and divide it by your total gross income. Multiply this number by 100 to get your percentage.
Let’s see the equation in action:
- Suppose you owe $200 in an installment loan, $300 in student loans, $726 in car payments, and $1,768 for your monthly mortgage. Together, these debts come to $2,994.
- The average full-time employee in the USA earns about $6,228 a month.
Knowing these figures, you can calculate your DTI this way:
$2,994 ÷ $6,288 = 0.47
0.47 x 100 = 47%
What’s a Good DTI?
If you have a DTI of 47%, you’re higher than most financial advisors recommend. They break down this ratio into three rough categories.
- Good: 0%–35%:
- Needs Improvement: 36%–49%:
- Warning: 50% and above
Why You Want to Lower Your DTI
A high DTI ties up your money, leaving you with less cash to spend as you like. This can come with steep consequences:
1. Difficulty Making Ends Meet:
Remember, your DTI isn’t a full snapshot of all your spending — just your debts. It doesn’t account for other bills and essential expenses. That’s why a DTI of 50% or more can be a big problem. With half of your income going to loans, you only have the other half of your income to buy everything else. During a cost-of-living squeeze, your debts can make it hard to make ends meet.
2. Limited Financial Flexibility
A significant portion of your income being used to service debt might mean you can’t save as well. Insufficient emergency savings push countless people to take out more loans online when they can’t afford an unexpected expense.
3. Higher Risk of Default
With a high DTI, there’s an increased risk you can’t pay your bills. This can result in late fees, higher interest rates, and, in extreme cases, defaulting on loans.
4. Challenges with Credit
Your DTI is not one of the official things that can harm your score; however, it may interfere with your next loan application. Some lenders may consider your DTI ratio when approving you for loans or lines of credit. If your ratio is too high, these lenders may reject your request for funds.
5. Impact on Future Financial Goals
Saving for long-term goals like homeownership, education, or retirement becomes more challenging when a substantial portion of your income is committed to debt. Debt may also interfere with your ability to invest and grow wealth.
7 Ways to Lower Your DTI Ratio
Here are seven tips to help you manage your debt load.
1. Create a Budget
Making any changes to your financial situation is easier when you have a budget. It’s both a plan of action and a litmus test. By showing you how you spend your money each month, you can prioritize responsible spending habits.
Start by creating a detailed budget that outlines your income, essential expenses, and discretionary spending. Identify areas where you can cut back to allocate more funds towards debt repayment.
2. Prioritize Debt Repayment
Use your budget to find areas where you can cut back. Streaming services, subscriptions, takeout, books, concerts, etc. — these are prime areas of saving. Anything you can manage to eliminate or reduce frees up cash you can funnel toward debt.
Focus on paying down high-interest revolving debt, or your lines of credit and credit cards. These have the potential to accrue interest (and therefore grow in size) the longer you have them.
3. Increase Income
Let’s face it — sometimes, you can’t get blood from a stone. In other words, you can’t free up money by cutting back on takeout if you never get takeout to begin with. For those on shoestring budgets, you might have to think about the other side of the DTI equation: your income.
Look for opportunities to boost your income, such as taking on a part-time job, freelancing, or exploring side hustles. Whatever you earn with these extra jobs can go directly toward debt.
4. Refinance or Consolidate Loans
Paying down debt can be hard when you have a lot of high-interest loans adding interest to what you owe every month. In some cases, you might be able to reduce your interest accrual through refinancing. By consolidating your debt into one loan, you might be able to lower your interest rate and consolidate your payments into one.
Make sure you test out a consolidation loan in a loan payment calculator before you accept anything. You don’t want to move around your debt if you don’t get anything out of it — or worse, accept terms that are actually harder to pay.
6. Talk with a Debt Counselor
If you’re having a tough time balancing your budget, find a debt counseling program. Many debt organizations provide free consultations, providing you with professional advice on how to manage your debt.
7. Avoid Taking on New Debt
When you work hard to lower your DTI, you don’t want to ruin your efforts by adding to what you owe. Try to avoid taking out new loans or lines of credit whenever possible. Delay big purchases and use your budget to focus on emergency savings. These savings replace the safety net of loans in unexpected expenses.
Bottom Line:
Consider your DTI a key performance indicator for your finances. Too high, and this ratio indicates you can run into problems — if you haven’t already.
So, what are you waiting for? Follow the instructions above and find out your ratio.
If your score is higher than 36%, find out how you can pay down your debts quickly.
What if you’re below this benchmark? You may still want to try out the tips shared here today. Anyone with debt should know how they intend to pay off what they owe. Eliminating your monthly debt payments frees up your cash for things you really want to buy.
Jeena Alfredo is a passionate digital marketer at The Business Goals. She is working with other companies to help them manage the relationship with The Business Goals for the publications.
