6 Top Ways to Lower Your Debt to Income Ratio
If you have a high debt-to-income ratio, you may find it challenging to secure lending.
Contributing Writer at Tally
July 28, 2021
If you are a borrower looking to buy a home or take out a loan, you may think lenders are only concerned about your credit score. However, this is not the case. Your debt-to-income ratio (DTI ratio) gives lenders a look at your personal finances, as it measures your debt obligations versus your monthly income.
Having a low DTI makes it easier to work with lenders. A DTI ratio of 43% is the max that borrowers can have and still receive a qualified mortgage.
Let’s review how to lower debt-to-income ratios, including actionable tips that could help lower your DTI.
Debt-to-income ratio — the basics
Your debt-to-income ratio is a measure of how much you spend on debt each month. It includes debt from:
Mortgages, property taxes and homeowner’s insurance
Credit card payments
Alimony and child support
To calculate DTI, divide monthly debt payments by gross monthly income. Multiply that by 100 to put the number into percentage form. This is your DTI ratio percentage. As mentioned, 43% is the highest DTI ratio you can have to still work with mortgage lenders. Other lenders may have their own limits when qualifying potential borrowers.
Ultimately, lowering your DTI ratio comes down to one of two things. You should either:
Reduce your total monthly debt
Increase your monthly earnings
Paying down debt is an easier short-term fix, while raising your income should be considered a more long-term solution.
Paying off debt is one of the most beneficial ways to earn a lower debt-to-income ratio. Having minimal debt is a good measure of financial health, as it shows that you're responsible when borrowing money. Lower debt can also lead to higher credit scores.
How to lower debt-to-income ratio
Though your DTI ratio comes down to either lowering your debt or raising your income, there are different ways of accomplishing both. Below are six tips that can help you secure a lower DTI ratio.
1. Lowering your interest rate
Whether you have a fixed-rate car loan or are dealing with compounding interest on credit card debt, reducing your interest rate can save you a significant amount of money. By refinancing your interest rate, repayment becomes easier because you don't owe as much to your lender.
Start by calling your lender to negotiate a lower interest rate. If you have a strong credit report and a history of making on-time payments, your lender may be willing to negotiate a lower rate.
If that doesn’t work, you may want to explore other options. Balance transfer credit cards and debt consolidation loans are both viable options to help refinance and lower your interest rate.
2. Extending your loan term
Another way to reduce your DTI ratio is by extending your loan term. When you extend your loan term, your loan payments are stretched out over a longer period. This, in turn, reduces how much you owe each month, which means a lower monthly bill.
For instance, if your mortgage payment is $1,500 per month, you can refinance with your mortgage lender and increase your term from 15 to 30 years. You are still paying the same total amount for the loan, but you stretch it out over a longer period, reducing your monthly minimum payment.
The exact amount of the reduction depends on your down payment and the amount outstanding on your mortgage. But, as an example, say your monthly payment is now $1,000. You’ve reduced your monthly debt obligation by $500, which in turn lowers your DTI ratio.
3. Monitoring your spending
Credit cards are tempting because they allow you to borrow money instantly. This can lead to overspending on unessential items. Credit card balances can be hard to pay off because of compounding interest.
If you have a high DTI, look at your credit card balances and your financial habits. Consider spending only with cash or a debit card. Also, consider crafting a budget as well as short- and long-term financial goals.
4. Finding a side hustle
Side hustles have become increasingly more common over the last few years. More than 57 million Americans had a source of side income last year, which has helped close the income gap.
Working a side hustle is a bit different, as it increases income rather than reducing debt. It is perhaps one of the easiest means of raising income. Securing a side hustle may be easier than getting a raise or promotion at work. It’s also a more short-term, immediate solution compared to waiting for a raise or bonus.
Even earning an extra couple hundred bucks a week can help if you have high DTI. Increasing your income also puts extra funds in your pocket that you can use to pay down your existing debt.
5. Using tools and apps to lower your debt
When working to pay off debt, consider researching the debt avalanche and debt snowball methods. One calls for you to pay off your debt with the highest interest rate first, while the other requires you to pay off your debt with the lowest balance first.
By lowering your debt, you'll reduce your credit utilization ratio and, in turn, your DTI ratio.
Of course, there are tools available to help you pay off your debt. One such tool is Tally. Tally is an automated credit card payoff app offering a low-interest line of credit that helps pay down your existing balances through the debt avalanche method. Because the service is automated, you don't have to worry about missing due dates.
6. Looking into loan forgiveness or debt settlement
If the above methods don't work, you may want to look into loan forgiveness or debt settlement. However, these should be last resort methods.
Both debt settlement and loan forgiveness can have long-lasting impacts on your credit score. Even though you'll have lowered your DTI, your credit score may be too low to secure funding.
Also, loan forgiveness is typically only available with federal loans. Consider consulting with a financial expert before deciding to settle your debt or seek out loan forgiveness.
Lowering your DTI ratio for better success with lenders
Whether you’re a first-time homebuyer entering the real estate market or someone looking to take out a personal loan, there's a good chance that your lender will evaluate your DTI ratio.
A DTI ratio is a strong measure of financial health, as it indicates how much of your monthly income goes toward debt. When applying for a new loan, lenders will consider the likelihood of repayment when offering your rate and term length. The lower the DTI ratio, the higher likelihood you have of securing the best rate.
There are ultimately only two ways to lower your DTI ratio. You can either increase your income or lower your debt. Lowering your debt is often easier in the short term. Doing so also helps build credit.
If you have credit card balances causing high monthly debt payments, be sure to look into Tally. Tally is a credit card payoff app that automatically pays off your credit cards with a low-interest line of credit in the most efficient way possible. By doing so, you free up cash that you can use to pay off other debts, thereby lowering your DTI.