Deconstructing Your Debt-To-Income Ration

Your debt-to-income ratio (or DTI) measures your monthly debt payment against your monthly income (before taxes or before other deductions have been made). To calculate your DTI, add your total monthly debt payments and divide them by your total pretax monthly income. For example, if you pay $200 a month toward your car loan and another $800 toward your mortgage, your monthly debt payments are $1,000. If your pretax monthly income is $4,000, your DTI is 25% ($1,000 divided by $4,000).Guidelines vary widely, but in general, a DTI of 35% or less is preferred by lenders (closer to 20% is ideal), whereas a DTI over 45% is likely to be considered problematic. Lenders use your DTI ratio to measure your ability to manage debt — so having a low DTI is very important, especially when it comes to buying a home, car or other major asset. The following are some ways to lower your DTI ratio.

Pay Off Debt

Surprise! While it’s easier said than done, reducing your debt can help you reduce your monthly payments, and therefore the percentage of your monthly income going toward debt. Aside from lowering your DTI, paying off your debt can also improve your credit score by reducing your credit utilization ratio, which is your total debt divided by your total available credit. A higher credit score could help improve your chances of qualifying for a mortgage or getting a favorable interest rate.

Increase Your Income

Increasing your income is another way to reduce your DTI. Not only will you have a higher gross income for the calculation, but you’ll also have the opportunity to put more money toward your debt, which can further reduce your DTI. A few ways you might increase your income include working toward a work promotion, working overtime or picking up a second job or side gig.

Lower Your Monthly Payments

By reducing your monthly debt payments, you can reduce the percentage of your income being used for debt. There are several ways to lower your monthly payments, including refinancing your loans or negotiating the interest rate on your debt. While negotiating your interest rate may be possible for credit cards, installment loans — like personal loans, auto loans or student loans — will likely require a refinance to adjust the rate.

Reduce Your Nonessential Spending

Look at where your money is going every month and cut back as much as you can. For example, are you paying for things like subscriptions that you no longer need? Freeing up that extra money in your monthly budget means you’ll have more available to pay off debt. And the more quickly you can pay off debt, the more quickly you can reduce your DTI.

Increase Your Down Payment

When lenders calculate your DTI, they consider the impact of a mortgage loan on your finances and aim to keep your DTI with your mortgage under a certain level. You can reduce your DTI when you own a home by putting down a larger down payment, which will result in lower mortgage payments each month.

This material was prepared by LPL Financial, LLC.

This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation.

Kmotion, Inc., 412 Beavercreek Road, Suite 611, Oregon City, OR 97045; www.kmotion.com

© 2022 Kmotion, Inc. This newsletter is a publication of Kmotion, Inc., whose role is solely that of publisher. The articles and opinions in this publication are for general information only and are not intended to provide tax or legal advice or recommendations for any particular situation or type of retirement plan. Nothing in this publication should be construed as legal or tax guidance, nor as the sole authority on any regulation, law or ruling as it applies to a specific plan or situation. Plan sponsors should consult the plan’s legal counsel or tax advisor for advice regarding plan-specific issues.