One of the important requirements when getting a loan is that you have a stable means of paying the borrowed money or the asset. In other words, you need a job that provides you with a stable income. Part of your income will be used to pay your debts.
There is a relationship between your debt and salary that is crucial to your credit activity called the debt-to-income ratio. This refers to the part of your income used to pay back what you owe your lenders. If you want to expand your credit activity, you need to know how important your debt-to-income ratio is for you. The following is information about the debt-to-income ratio and how important it is to someone with credit activity.
What is a Debt-to-Income Ratio?
The debt-to-income ratio is the percent of your salary used to pay for your debts and the fees that come with it. It is often used by lenders as a means of creditworthiness and can deem you fit or unfit for the loan you want to apply for. The lower the ratio is, the more and better deals you can get.
How can you find your debt-to-income ratio? You can compute for it yourself. Take the sum of all the debt payments you need to pay every month and other loans plus their interest rates, and divide it by your monthly income. The answer will be a decimal; to convert it to a percentage, multiply the decimal by 100.
Debt-to-Income Ratio and Lending
A person’s debt-to-income ratio is taken into consideration when he or she wants to apply for a loan or any form of consumer debt. As previously mentioned, the lower your ratio is, the better. It would be best to have a lower debt-to-income ratio to get more credit opportunities.
This is because the lenders have to make sure that you have the means to pay back what you borrowed or financed. Looking at how much you earn and how much of that is used to pay various debts, you need to make sure that whatever is left from your income can still suffice as payment for the new loan or debt payment. The highest ratio that can be accepted for even a decent mortgage is 43%.
Now and then, especially when dealing with credit, regularly calculate your debt-to-income ratio. Knowing the percentage can give you an idea of whether you can take on a new debt payment or not without entirely relying on lenders’ assessment that may take longer than you need.
If you have a ratio that seems passable, that could serve as a reference for looking for suitable lenders whose offers and monthly payments are within your financial reach. If you have a high debt-to-income ratio, it would be best to lower it. As much as possible, settle for the best percentage you can achieve so you will unlikely encounter troubles while paying for the debt.
How to Lower Your Debt-to-Income Ratio
If your current debt-to-ratio does not pass within lenders’ standards, you need to lower it. There are several ways to do so:
Pay Off your Debts Early
One obvious solution to lower your debt-to-income ratio is to let go of debt. If you have debt payments or other loans that you can pay off early, it would be better to pay it off, as long as the amount it takes to pay it all off does not get in the way of your daily expenses. Ensure that this debt is something you can pay in advance as some of them are only payable within a specific date.
Do it slowly to not harm your budget, and begin with the most financially manageable ones. Not only will it lower your ratio, but it will also improve your credit score, another important requirement to get the loan.
Avoid Getting Other Debts
This may sound odd, knowing that you need a low debt-to-income ratio to have more opportunities with your credit, but what this means is that you need to prioritize getting only one loan. The next one has to be what you need the most at the moment.
It’s best not to take several loans at once, or else your income may not be enough to pay for them. Not to mention your ratio and credit score will become higher, making you more ineligible to get debt.
Look for Another Source of Income
This is more optional than the other two and can be done when an opportunity can come your way. Another idea to lower your debt-to-income ratio is to increase your income. You can switch to a better-paying job or get another job you can manage alongside the one you already have.
Keep Your Debt-to-Income Ratio Low
Your debt-to-income ratio matters in your credit activities because it is how much you’re taking from your income to pay for the debts you currently have. If you wish to take on another debt, you need to make sure that your ratio is low enough that you have part of your income to spare for the debt. This gives you more opportunities to get better offers at the best prices possible.