When it comes to managing your finances, one of the most significant numbers to keep an eye on is your debt-to-income ratio, or DTI. It might sound technical, but your DTI plays a huge role in shaping your financial health – especially if you’re trying to build or maintain good credit and be smarter about your borrowing.
In fact, understanding and managing your DTI could be the difference between getting approved for a loan with favorable terms and facing roadblocks on your financial journey.
Let us walk you through what debt-to-income ratio is, why it’s important, and how maintaining a healthy balance between debt and income can improve your credit score and borrowing power. Plus, we’ll explain how partnering with a certified, nonprofit credit counselor through the CredEvolv platform can help you achieve an ideal DTI and stay on the path toward financial wellness.
What is Debt-to-Income Ratio (DTI)?
Let’s break it down: your debt-to-income ratio is a simple formula that compares the amount of debt you owe each month to your gross (pre-tax) monthly income. It’s expressed as a percentage, which lenders use to determine how well you manage your existing debt and whether you’ll be able to take on more credit responsibly.
Here’s how you can calculate it:
- Add up your monthly debts. This includes all recurring debt payments, like your rent or mortgage, credit card minimums, car loans, student loans, and any other monthly loan payments.
- Divide by your gross monthly income. Take the total of your monthly debt payments and divide it by your pre-tax monthly income.
- Multiply by 100 to get a percentage. The result is your DTI ratio. For example, if you pay $2,000 a month toward debt and earn $5,000 before taxes, your DTI would be 40%.
Why does DTI matter when you’re trying to get a loan?
Lenders look at your DTI ratio to gauge how much of your income is already tied up in debt payments. A lower DTI signals to lenders that you have room in your budget to take on more debt without overextending yourself. On the other hand, a higher DTI might raise red flags, suggesting you could struggle to manage additional monthly payments.
In general:
- A DTI below 36% is considered good and indicates you have a manageable level of debt.
- A DTI between 36-49% is acceptable but may make it harder to qualify for some loans or the best interest rates.
- A DTI above 50% could limit your borrowing options and indicate that you’re at risk of becoming overwhelmed by debt.
Can having some debt actually help my credit score?
It may seem counterintuitive, but carrying some debt can actually benefit your credit score – if it’s managed wisely. That’s because your credit score is based on several factors, including the types of credit you use, how long you’ve had credit, and how responsibly you handle debt.
Here’s how carrying a bit of debt can work in your favor:
- Diverse credit types improve your score. Having a mix of different types of debt – such as a mortgage, car loan, and credit cards – can positively impact your credit score. It shows lenders that you can handle various types of credit responsibly.
- Open tradelines signal active credit management. Lenders want to see that you can responsibly use credit over time. If you have open tradelines – such as a credit card or loan – it shows you’re actively managing your credit. As long as you make timely payments and keep balances low, this can boost your score.
- Responsible debt management builds trust. When you consistently make on-time payments and keep balances under control, you’re proving to lenders that you’re a trustworthy borrower. This can raise your credit score and increase your chances of getting approved for new loans with better terms.
Why is it important to keep your DTI ratio manageable?
While having some debt can help your credit score, it’s important to keep your DTI ratio in check. When debt starts to outweigh your income, it can become difficult to manage monthly payments, leading to late or missed payments. That can hurt your credit score and cause stress.
Here are a few reasons why maintaining a healthy DTI ratio is crucial:
- Protect your credit score. If your DTI gets too high, it could lead to financial strain, making it harder to keep up with payments. Even one missed payment can cause your credit score to drop significantly.
- Avoid higher interest rates. Lenders charge higher interest rates to borrowers with high DTIs because they’re considered riskier. By keeping your DTI ratio low, you increase your chances of qualifying for loans with lower interest rates.
- Reduce the risk of falling into a debt spiral. The higher your DTI, the harder it becomes to pay down debt, especially when you’re only able to make minimum payments. This can lead to a cycle of increasing balances and interest charges, making it more difficult to achieve financial freedom.
How can a credit counselor help me achieve an ideal DTI?
If you’re feeling overwhelmed by your debt or aren’t sure how to improve your DTI, help is available. Partnering with a certified, nonprofit credit counselor on the CredEvolv platform can provide the guidance and support you need to get back on track.
Here’s how working with a credit counselor can make a difference:
- Personalized debt management plans. The credit counselor you partner with through CredEvolv will work with you to assess your financial situation and create a customized plan to help you pay down debt and lower your DTI.
- Budgeting advice. Maintaining a healthy DTI requires careful budgeting. Your credit counselor can help you develop a realistic budget that ensures you’re living within your means while steadily paying down debt.
- Educational resources. The credit counseling agencies on the CredEvolv platform can provide tutorials to help you better understand how to manage your debt, build your credit, and maintain a healthy DTI ratio moving forward.
The bottom line: Achieving balance for financial success
Your debt-to-income ratio is a key indicator of your financial health. Finding the right balance is essential for maintaining a good credit score and gaining borrowing power. By understanding how to manage your debt responsibly – and knowing when to seek help from a certified credit counselor on the CredEvolv platform – you can achieve a brighter financial future.
Remember, having some debt isn’t necessarily a bad thing. In fact, when managed wisely, it can help you build credit and demonstrate responsible borrowing. But keeping your DTI in check is crucial to avoid falling into financial trouble.
If you ever feel like your debt is starting to weigh you down, don’t hesitate to reach out to CredEvolv so we can connect you to a certified, nonprofit credit counselor. With the right guidance and a solid plan, you can lower your DTI, improve your credit score, and take control of your finances – both now and in the future!