As a homeowner, one of the most important numbers to keep an eye on is your debt-to-income (DTI) ratio. This ratio is a comparison of the amount of debt payments you owe each month to the amount of money you earn. Lowering your DTI ratio can lead to better credit scores and more access to lending options in the future.
Understanding the Debt-to-Income Ratio
As a homeowner, understanding your debt-to-income (DTI) ratio is critical to managing your finances and achieving your financial goals. Simply put, DTI is a measure of your debt relative to your income. Your DTI ratio is calculated by dividing your total monthly debt payments by your gross monthly income.
Lenders use your DTI ratio to determine your creditworthiness when applying for a mortgage or other loan. A lower DTI ratio typically indicates that you are more financially stable and able to make your loan payments on time. Ideally, your DTI ratio should be below 36%, although lenders may accept higher ratios under certain circumstances (many as high as 43, 45 or even 50%!).
Personal debt, such as credit card debt, is a common cause of high DTI ratios. By reducing your personal debt, you can lower your DTI and improve your chances of qualifying for a mortgage or other loan. Additionally, paying down your personal debt can help you save money on interest charges and fees, which can free up more money to put toward your mortgage payments or other financial goals.
Improve your DTI: Increase Your Income
One effective way to lower your debt-to-income ratio is to increase your income. There are several ways to do this, depending on your situation and skillset. I’d strongly recommend these strategies and pick one that works best for you.
1. Take on a side hustle
Consider taking on a part-time job or freelance work in your spare time. You can find work through websites like Fiverr or Upwork, smart apps like TaskRabbit, or consider offering your services locally through social media or community bulletin boards.
I have always had a part-time job and believe me it does help more than you’d ever think. Not only do you pay down debts, you get to lower your debt-to-income ratio and make it easier to manage your finances.
2. Rent out a room
If you have a spare room in your home, consider renting it out on Airbnb or other rental websites. This can be a steady source of income that can significantly boost your earnings. This additional income can pay down other personal debts.
3. Ask for a raise
If you have a steady job, consider asking for a raise or promotion. This may require additional education or training, but can be a long-term solution for increasing your gross income.
Bonus: Sell unwanted items
Although this step won’t necessarily help your DTI because it’s not consistent enough, I include it anyway because of how easy it is and helpful it’s been for my family. Look around your home for items that you no longer need or use and sell them online or at a garage sale. Websites such as Facebook Marketplace, Neighbor, Craigslist and similar are good ways to start. It’s important to screen potential buyers or meet them in a well-lit secure area. Overall, this can be a quick way to make some extra cash.
Improve your DTI: Decrease Your Debt
Reducing your debt is an important step to lowering your debt-to-income ratio as a homeowner. Here are some tips to help you reduce your debt:
1. Create a budget
Creating a budget can help you track your expenses and identify areas where you can cut back. Allocate a portion of your income to debt payments and stick to it.
2. Pay more than the minimum
Paying more than the minimum on your debts can help improve your debt-to-income ratio faster and save money on interest charges. This is especially true if your monthly gross income has risen and you have too much debt.
3. Prioritize high-interest debts
If you have multiple debts, prioritize paying off the ones with the highest interest rates first. This will save you money in interest charges in the long run. Student loan debt tends to be driven by your monthly gross income for most borrowers and may not be counted as one of your current monthly debt obligations.
4. Negotiate with creditors
If you are struggling to make payments, contact your creditors and try to negotiate a lower interest rate or extend the payment plan terms for a year or more that works for you.
5. Avoid taking on new debt
It can be tempting to take on more debt, but doing so will only increase your debt-to-income ratio and new credit inquiries negatively affect credit scores. Focus on paying off your existing debt before taking on any new obligations, unless you’re considering a loan for debt consolidation purposes.
6. Cut credit card debt
Reducing your debt balances on credit cards can also increase your disposable income and lower your credit utilization ratio. Look for ways to reduce your debt payments, such as consolidating multiple cards into one card through a low-interest promotional balance transfer.
By following these tips, you can reduce your debt and lower your debt-to-income ratio as a homeowner. Remember, many lenders prefer a low DTI ratio which means your monthly debt payments and gross monthly income are an important factor in regards to auto loans or your housing payment.
How to Lower Debt-to-Income Ratio with a New Mortgage
If you’re a homeowner struggling with high debt-to-income (DTI) ratio, refinancing your mortgage could be an effective way to reduce your monthly payments and increase your disposable income. Refinancing involves replacing your existing mortgage with a new loan that offers better terms, including lower interest rates, longer repayment periods, or lower monthly payments.
The primary benefit of refinancing your mortgage is that it can help lower your monthly mortgage payments, freeing up more money in your budget to pay off other debts or increase your savings. Additionally, refinancing can help reduce the amount of interest you pay over the life of your loan, ultimately saving you money in the long run.
To determine whether refinancing is a good option for you, consider the current interest rates, your credit score, and the length of your existing mortgage. Generally, refinancing is most beneficial when interest rates are lower than your current rate, and when you have a good credit score to secure a favorable rate.
When refinancing, it’s important to shop around for the best loan terms and rates. This means researching different lenders and comparing their offerings to find the most affordable option for your specific financial situation. Keep in mind that refinancing can come with costs, such as closing, underwriting, origination and appraisal fees, so be sure to factor these expenses into your decision.
If you decide to refinance, consider opting for a longer repayment term. While this may increase the overall cost of your loan, it can help lower your monthly payments and lower your debt-to-income ratio.
Perhaps you currently have 15 or 20 years left on your mortgage. If the new interest rate is higher than what you have now, consider refinancing into a 20 or 25-year mortgage and continue to pay your existing monthly payment in the months you can.
Additionally, refinancing your mortgage can be a good opportunity to consolidate other debts, such as credit card balances or personal loans, into one monthly payment.
Use Home Equity to Lower DTI
As a homeowner, you have the advantage of using your home equity to reduce your debt-to-income ratio. Home equity is the difference between the market value of your property and the amount of outstanding mortgage on your home. The following are some ways you can utilize your home equity to lower your DTI:
1. Home Equity Loan
One way to access your home equity is through a home equity loan. This type of loan allows you to borrow a lump sum of money using your home equity as collateral. This will become a debt consolidation loan to pay off high-interest debts, such as your Visa and Mastercard balances, property taxes, or personal loan. This will lower your monthly debts and help you have more disposable monthly income.
2. Home Equity Line of Credit (HELOC)
A HELOC is another option for accessing your home equity. It works like a credit card, where you can borrow as much money as you need up to a predetermined limit. A HELOC is a good option if you don’t need a huge lump sum. You can use the funds to make extra payments or pay off high-interest debts, which will reduce your debt levels.
3. Refinance with Cash-Out
If you have a lot of equity in your home and want to lower your monthly payments, you may want to contact mortgage lenders about a cash-out refinance. This allows you to refinance your mortgage for a larger amount than what you owe and receive the difference in cash. You can use the funds to pay off high-interest debts or other loans.
4. Home Equity Investment
Home Equity Investments, or Home Equity Agreements, are a way for homeowners to tap into their home equity without increasing their monthly payments. The homeowner sells a share of their home to investors in exchange for access to the future appreciation of their home. Since it’s in investment, and not a loan, the homeowner doesn’t need to pay anything back until they sell the property, in which case, the investors share in the home’s appreciation.
Utilizing your home equity can be a good option for lowering your credit utilization, but it’s important to remember that using your home as collateral comes with risks. If you’re unable to make your payments, you could lose your home. It’s important to weigh the pros and cons and consult with a mortgage advisor before making any decisions.
Other Options to Lower DTI
Aside from increasing your income and reducing your debts, there are other strategies that homeowners can consider to lower their debt-to-income ratio. Here are some other considerations:
1. Change Your Payment Plan
Some loans and credit card companies may offer you different payment plans. For instance, if you’re paying monthly on a loan, ask if they offer bi-weekly payments instead. Switching to bi-weekly payments can help reduce the amount of interest you pay in the long run.
2. Delay Large Purchases
If you’re planning on getting a car loan or any other big ticket item, hold off on it for a while. Otherwise, your loan application may have a lower chance of approval.
3. Consolidate Debts
Debt consolidation may be a viable option for homeowners who are struggling to keep up with multiple high-interest loans or credit card payments. Combining debts into one loan with a lower interest rate could reduce your monthly payments and lower your DTI.
How to Remove Personal Monthly Debt Payments
If you have high-interest rates on consumer credit, such as credit cards or loans, it can increase your monthly debt payments, and in turn, increase your DTI. Here are a few ways to decrease your DTI by removing personal debt.
1. Not really your debt
If you are a co-signer on an auto loan or credit card for a relative or friend to get them a better interest rate and terms but they have made all the payments for the last twelve months, consider getting copies of cancelled checks or bank statements from them to prove to the lender it is not your debt. Most lenders wipe out a car payment with documentation.
2. Auto loan paid by the company
If you have an auto or truck loan, but it’s paid or reimbursed by the company each month this is another debt that won’t always count against you if you provide sufficient documentation to the underwriter.
3. Less than 10 payments remaining
Lenders use underwriters who routinely don’t count installment loans with fewer than ten payments remaining against you in your DTI calculation. An exception is if it’s a lease because lenders believe you’ll sign a new lease with similar payment terms.
4. Move personal debt into business debt
If you’re a small business owner, consider moving some of your personal debt into business debt through a business loan or business credit card. By doing so, you can potentially qualify for lower interest rates, improve your credit score, and decrease your DTI.
Lower Your Debt to Income Ratio
In the world of homeownership and financial stability, the debt-to-income (DTI) ratio is a pivotal indicator of one’s economic health. Not only does a favorable DTI ratio open doors to broader lending opportunities, but it also acts as a reflection of responsible financial management. Remember, in the quest for financial empowerment, it’s not just about how much you earn, but also about how wisely you manage and allocate your resources.