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What is a debt-to-income ratio?
What factors make up a DTI ratio?
- Front-end ratio: also called the housing ratio, shows what percentage of your monthly gross income would go toward your housing expenses, including your monthly mortgage payment, property taxes, homeowners insurance and homeowners association dues.
- Back-end ratio: shows what portion of your income is needed to cover all of your monthly debt obligations, plus your mortgage payments and housing expenses. This includes credit card bills, car loans, child support, student loans and any other revolving debt that shows on your credit report.
How is the debt-to-income ratio calculated?
- Add up all of your monthly debts. These payments may include: monthly mortgage or rent payment, minimum credit card payments auto, student or personal loan payments, monthly alimony or child support payments or any other debt payments that show on your credit report
- Divide the sum of your monthly debts by your monthly gross income (your take-home pay before taxes and other monthly deductions).
- Convert the figure into a percentage and that is your DTI ratio.
What is an ideal debt-to-income ratio?
Does my debt-to-income ratio impact my credit?
How to lower your debt-to-income ratio
- Track your spending by creating a budget, and reduce unnecessary purchases to put more money toward paying down your debt. Make sure to include all of your expenses, no matter how big or small, so you can allocate extra dollars toward paying down your debt.
- Map out a plan to pay down your debts. Two popular ways for tackling debt include the snowball or avalanche methods. The snowball method involves paying down your small credit balance first while making minimum payments on others. Once the smallest balance is paid off, you move to the next smallest and so forth. On the other hand, the avalanche method, also called the ladder method, involves tackling accounts based on higher interest rates. Once you pay down a balance that has a higher-interest rate, you move on the next account with the second-highest rate and so on. No matter what way you choose, the key is to stick to your plan. Bankrate.com's debt payoff calculator can help.
- Make your debt more affordable. If you have high-interest credit cards, look at ways to lower your rates. To start, call your credit card company to see if it can lower your interest rate. You might have more success going this route if your account is in good standing and you regularly pay your bills on time. In some cases, you may realize it's better to consolidate your credit card debt by transferring high-interest balances to an existing or new card that has a lower rate. Taking out a personal loan is another way you could consolidate high-interest debt into a loan with a lower interest rate and one monthly payment to the same company.
- Avoid taking on more debt. Don't make large purchases on your credit cards or take on new loans for major purchases. This is especially important before and during a home purchase. Not only will taking on new loans drive up your DTI ratio, it can hurt your credit score. Likewise, too many credit inquiries also can lower your score. Stay laser- focused on paying down debt without adding to the problem.