How do I improve my debt to income ratio?
First of all, if you’ve ever talked to a bank and they threw that language at you, let’s just make sure that you understand what it actually means.
There’s an amount of money that you’re making and that’s your income but as you acquire a debt, that revolving debt has payments that are owed.
Like if I bought a car and I had a $500 payment, well, I might be making $5,000 a month but the banks are going to say, yeah, but what’s your debt to income ratio? We want to know how much money you really got to play with based on the financial choices that you made. That car is costing you $500 a month so even though you’re making $5,000, it’s more like you got $4,500.
Well but I also have this house payment that’s $1,500 a month.
Well then you’re not really at $4,500 now you’re more $3,000, right?
And the bank really wants to figure out what discretionary money you have to play with. They want to know whether you’re a good candidate for a mortgage.
So let’s just really drill down on how you reduce your debt to income ratio.
You’ve got your debts and you’ve got your income.
So for example, if you pushed and got a raise at work, then your income would go up higher and if your debts didn’t change then that ratio would change and the banks would say, “Oh, you’ve got a better income ratio against your debts.”
Similarly you could say that you’ve got three credit cards that you’re paying on and one of them has high interest and you were just paying them all off together and as you’re paying them down, it’ll improve your debt to income ratio.
But part of that debt to income ratio that banks will often look at but not tell you is like what are your interest rates? So you might want to start snowballing some of your extra money and consolidating your debts by paying off just this one high interest rate credit card. That’s going to improve your debt to income ratio.
You might have a philosophy that says “Hey, I’m putting away $500 a month in savings or right now, I’m electing to put more money in my 401k” but if you need to improve your debt to income ratio, you can allocate that money to reducing your debt and that’s going to make your income look better to your debt.
So ultimately, there’s really only two levers to pull on.
One of them is income, the other one is your. Ultimately, the goal is to focus your discretionary income on your debts and if you’re going to do that anyway, do it on your high interest debts anyway, and what that’ll do is that’ll help open up a margin.