What is debt to income ratio
Your debt-to-income ratio (DTI) measures how much you pay to service your debts relative to your income. To lenders, it is an important indicator for whether you are a good prospect for a loan and a critical component of your PRO Index.
To you, it can be a measure of financial health by showing how much of your monthly income is going to servicing your debts, which is something you should keep at all times so you don’t end up taking on more debt than you can handle as a borrower.
Why is it important?
A low debt-to-income ratio demonstrates a good balance between debt and income. In general, the lower the percentage, the better the chance you will be able to get the loan or line of credit you want.
How to reduce it?
- Lower the interest on some of your debts
For some of your debts, you can look into ways to reduce the amount of interest you’re paying on them.
For example, you can lower your interest rate on your credit card debts through a credit card balance transfer, which is something we discuss in another one of our articles.
- Extend the duration of your loans
Extending the duration of a loan can be a way to lower your monthly loan payments on the debt. However, you may have to pay a higher interest rate to compensate.
- Find a source of side income
Finding another stream of side income can be helpful in increasing your income (thereby lowering the DTI ratio) and fulfilling your debt obligations.
For example, you can find side income by driving for Uber, renting your spare room out on Airbnb – to name a few potential ways.
- Look into loan forgiveness
This isn’t typically an option for private loans (unless you count debt relief programs, which can harm your credit score).
For federal loans, however, loan forgiveness can be an option, especially for student loans.
- Pay off high interest debt
Make a list of the debt payments that you make every month.
Which of your debts demand the highest monthly payment? Try to pay that debt off first to lower your DTI and credit utilization ratio. Alternatively, you can try to lower that payment by extending your repayment timeline. You can automatically determine which debt to pay off first and see the amount of interest savings you’ll make by using a debt snowball calculator. In general, whenever you can afford to make more than the minimum payments, you are optimizing your DTI ratio.
Solution for Student Loan
Student loans have seen almost 157 percent in cumulative growth over the last 11 years. All told, there’s a whopping $1.4 trillion in federal student loans out there. Experts and analysts worry that the next generation of graduates could default on their loans at even higher rates than in the immediate wake of the financial crisis.
Federal student loan debt currently has the highest 90+ day delinquency rate of all household debt. More than 1 in 10 borrowers is at least 90 days delinquent, while mortgages and auto-loans have a 1.1 percent and 4 percent delinquency rate.