Debt-to-income (DTI) ratio

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The importance of your debt to income ratio

Your debt-to-income (DTI) ratio shows you much debt you are carrying in relation with how much money you are making. A low DTI is better than a high DTI. This is another tool that you can use to measure the success of your debt help plan.

A low ratio means your debt is under control and you have sufficient cash flow to live comfortably. A high one means so much of your income is going to pay off or manage debt that you are going to have a tough time paying off debt while holding on to sufficient cash to take care of your daily expenses, let alone have any funds remaining for saving or investing.

A DTI number of 36 percent is about as high as you want to go if you are serious about obtaining credit or loans at a decent market rate. Once you exceed 38 percent you are entering risky territory for most lenders and this will greatly complicate or perhaps even negate your ability to borrow.

An Internet search will produce a list of a number of sites that contain DTI calculators and go into far more detail regarding the ways in which this affects your borrowing ability and credit report scores.

Ways to reduce your debt-to-income ratio

At times and under certain circumstances, a high DTI may be acceptable to lenders, but only if you are actively and aggressively working on paying off and lowering your total debt. If you have an unacceptably high DTI and your creditors report that you are still making minimum payments, this is a potentially serious problem.

Generally, there are two ways to improve your DTI ratio. One, increase your income by requesting overtime, assuming a part-time job, or generating money from freelance work or turning a hobby or interest into a home-based small business. Increasing your monthly income while maintaining your debt stability and paying bills on time will actually lower your DTI.

Two, pay off your debt. As soon as your debts are reduced to zero, your debt-to-income ratio will drop dramatically. However, as noted above, while you're still paying down your debt, your DTI ratio will jump. For example, if your monthly income is $1,000 and you dedicate $480 of that to paying down your debt, your DTI ratio is 48 percent. If you spend $700 a month on these payments, your ratio would pop up to 70%. However, when you become totally free of debt, your DTI will drop to 0 percent.