Debt to Income Ratio

The debt-to-Income (DTI) ratio is a financial measurement used to evaluate an individual’s ability to repay their debts and is a crucial part of your overall financial health. It’s calculated by dividing the total monthly debt payments by the total monthly gross income. The result is expressed as a percentage. Why does this matter?

Why Your Debt-to-Income Ratio Matters

Keeping your DTI ratio at a moderate level signals that you’re a responsible manager of your debt, which can improve your credit score and eligibility for financial products. A general rule of thumb is to keep your overall debt-to-income ratio at or below 43%.

It shows how balanced your spending plan is and assesses your creditworthiness.

A ratio below 43% is seen as a wise target because it’s the maximum debt-to-income ratio at which you’re eligible for a Qualified Mortgage —a type of home loan designed to be stable and borrower-friendly. A DTI ratio of 43% or lower is generally considered ideal for most borrowers. The borrower’s debts, including mortgage payments, credit card payments, car loans, and other debt obligations, should be at most 43% of their monthly pre-tax income. If the DTI ratio is higher than 43%, it may indicate that the borrower is overextended and may have difficulty paying debt obligations.

Keep in mind that the DTI ratio is just one factor that lenders use to evaluate loan applications. Other factors, such as credit score, employment history, and assets, are also considered.

Less Favorability in your Spending Plan and Borrowing Terms

When a significant portion of your income goes towards paying debt, you have less left to save, invest, or spend on things you want and need. Additionally, if you have a high debt-to-income ratio, you will be seen as a riskier borrowing prospect. When lenders approve loans or credit for risky borrowers, they may assign higher interest rates, steeper penalties for missed or late payments, and stricter terms.

A debt-to-income ratio over 43% may prevent you from receiving a qualified mortgage, limiting you to approval for home loans that are more restrictive or expensive.

And although it Is used a lot in qualifying people for mortgages, it can be used to manage money and debt better. As interest rates increase, decreasing and lowering your debt burden becomes more critical.

Different Types of Debt-to-Income Ratios

There are two main types of DTI ratios – front-end ratio and back-end ratio. The Front-end DTI ratio calculates the income percentage used to pay housing expenses, such as mortgage or rent payments. The back-end DTI ratio considers all debt payments, including housing expenses, credit card debt, student loans, and car loans.

Importance of Debt-to-Income Ratio for Loan Approval

A low DTI ratio is a positive sign for lenders, as it may indicate that borrowers have the financial stability to repay their debts. A high DTI ratio can signal to lenders that borrowers may struggle to repay their debts and may be at a higher risk of defaulting on their loans. As a result, lenders may only accept loan applications or offer more favorable terms to borrowers with high DTI ratios.

How do you Calculate the Debt-to-Income Ratio
  1. Add up your monthly debt payments (rent/mortgage, student loans, auto loans, and monthly minimum credit card payments).
  2. Find your gross monthly income (your monthly income before taxes).
  3. Debt-to-income ratio = your monthly debt payments divided by your gross monthly income.

Here’s an example:

You pay $1,900 a monthly for your rent or mortgage, $500 for your car loan, $300 in student loans, and $400 in credit card payments—bringing your total monthly debt to $3100.

Your gross monthly income is $6,500.

Your debt-to-income ratio is 3,100/6,500, or 47%.

A Debt-to-Income Ratio of 36% or Less

A debt-to-income ratio of 36% is considered a good debt-to-income ratio. With a DTI ratio of 36% or less, you have a healthy monthly income to put towards investments or savings. Most lenders will see you as a safe bet to afford monthly payments for a new loan or line of credit.

DTI Ratio and Credit

Credit reporting agencies don’t collect consumers’ wage data, so a debt-to-income ratio won’t appear on your credit report. Credit reporting agencies are more interested in your debt than income history. Although your credit score isn’t directly impacted by your debt-to-income ratio, lenders or credit issuers will likely request your income when you submit an application. Just as your credit score will be one factor in their application review process, your debt-to-income ratio will also be considered. A high DTI ratio can hurt a person’s credit options as it can indicate that they are overextended and may struggle to repay their debts. A low DTI ratio can help improve credit options as it shows that a person is financially responsible and able to manage their debts.

Improving your DTI Ratio

If you have a high DTI ratio, you can take steps to improve it. This can include paying down debt, increasing income, or a combination of both. Reducing monthly debt payments by paying off credit card debt or negotiating lower interest rates can also help improve the DTI ratio.

By regularly monitoring your DTI ratio, you will identify areas where they can reduce debt or increase income to improve their financial stability.

The DTI ratio also provides you with a good snapshot of your current financial health. If it’s below 36%, you’re in a good position to take on new debt and pay it off with regularity. But when it’s over 50%, you should try to reduce the number of debt obligations (by either working to pay off credit cards, find a more affordable home, or refinancing your current loans) or find ways to generate more income. When your DTI falls between 35% and 50%, you’ll usually be eligible for some approvals. Even so, your financing terms on lines of credit will be better if you hit the premium level of sub-35% debt-to-income.

The DTI ratio is useful for individuals to assess their financial situation and determine if they are overburdened with debt. It’s also a valuable tool for lenders to evaluate the creditworthiness of loan applicants and determine the risk of loan default. Maintaining a low DTI ratio can help individuals improve their chances of being approved for a loan and ensure that they are in a better position to repay their debts, and ensure they are on a path to financial security.

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Tips to Organize Your Financial Life

For someone with a history and pattern of financial chaos, the first step toward better money management could be to just organize your financial life. Organizing your financial life requires a clear picture of where you are and where you want to go with your money. I believe you must know where your money is going, and where it’s being spent, to manage it effectively. Knowing where your money is going is one of my GoldenRules of financial management. Additionally, you must know where you are in terms of income, and debt. You will also need some SMART financial goals to lead the way to a better financial future. To help you accomplish this task, set up a system to track your expenses, income, and pay bills. 

Getting organized can be overwhelming and can stop the best of us even before we start. To help you get organized, use the organization tips below.

Tip #1. Get Organized by Setting Up a Tracking System

Set up a system to track expenses appropriately for your needs. The system could be as simple as a piece of paper and pencil or a spreadsheet on your personal computer. Before you do anything with your money, you must know where you are spending it and where it’s going. Again, this is a GoldenRule to managing money better.

In this case, knowing is more than half of the battle. I believe knowing allows you to see your spending and adjust it to help you meet your financial goals and not overspend. It’s a must for managing money effectively. You must know where your money is going before you can manage it effectively. 

Tip #2. Track Your Spending

If you have not already done so, start documenting your spending. Use that paper and pencil or spreadsheet and document, document, document. Once a week or even every day. Once a week will be less time-consuming, but from experience, it’s easy to forget some days, and daily, at least when starting, maybe the better way. However, tracking your spending will get easier the more you do it because you are creating a good habit.

Tip #3. Set Up a Consistent Place to Work Your Money

Whatever way you decide to track spending, you need a place to do that. Therefore, set a place where you will weekly or daily record your expenses, pay bills, and compare financial goals to reality. I call this “working your money”. Working your money is one of my GoldenRules to manage money better.

I believe in working your money. Please know that working your money takes time, it’s a job. However, you must work your money because if you don’t, someone else will, and you will be wondering where your money went and how you spent it on that.

Also, when working your money, compare your spending plan with your actual expenses. Comparing will help you stay focused on your system and organize your financial life. And be consistent. Pick a day and time to work your money, Sunday after church, Monday after work, Saturday morning, unless you have kids because they will be up before you. 

Tip #4. Don’t Make Your System Too Complicated (KISS)

In setting up your system, it is helpful to be as thorough as necessary for your needs but not too complicated to where you get bogged down, bored, and do not continue with it. The key is to have a system that is not intimidating to you. One of the goals of the process, besides organizing your financial life, should be to help you learn to manage your finances. As a money nerd, it’s hard to keep it simple sometimes, but try to use the KISS principle, for Keep It Simple Sweetie.

Tip #5. Organize Your Financial Life by Using a Spending Plan

If you are an over spender and cannot stick to your spending plan, perhaps setting up two bank accounts can help. Set up one account that you would use to pay bills and another discretionary account for discretionary expenses. The amount is based on your spending plan and used for discretionary expenses only. Using a spending plan is another GoldenRule.

Be aware that setting up a system that works well for you may take some trial and error. It is important to be patient and to make a commitment to working your money. Sometimes a perceived problem in the plan could be reluctance on your part and turn into a great opportunity. 

Final Thoughts on Organizing Your Financial Life

There are huge benefits to organizing your financial life. Ultimately organizing your financial life will help you make better financial decisions. Additionally, I believe that organizing helps you to be a better steward of your money. Additionally, the plan can help you develop a healthy relationship with money. You will start to see money as a tool to help you achieve financial goals. How do you organize your financial life? Comment below, I would love to hear form you..

Methods and Tips to Help You Track Expenses

There is no short answer to the best method for tracking your expenditures question. The best approach is one you feel comfortable enough to stick to every day and follow through on. Follow the tips and methods below to help you track expenses. 

Track Expenses with Pencil and Paper

If you prefer a tech-free solution for tracking your expenses, write down every penny you spend and where you spent it in a notebook. Simply use one page and note the category next to each expenditure. This may be the method to use if you are new to creating spending plans. This approach can tell you immediately where your money is going and immediately make you aware of your spending.

Using an App or Software to Track Expenses

A modern and perhaps more convenient way to track expenses is in a spreadsheet or a web-based financial app. With online apps or software, you can create colorful graphs and charts to illustrate your spending habits. Both methods allow you to quickly and easily enter your expenditures into a spending category daily.

Work Together as a Couple

If you are in a relationship and have combined finances, you will both need to track your expenses. It’s a good idea to choose an online app or another expense-tracking method that can sync your spending with your spouse’s spending so that you don’t blow your budget.

Smartphone apps for couples allow you to track spending on the go. This can prevent the two of you from spending in the same category at the same time and will give you a sense of how much you have left in a spending category so that you can stick to your spending plan.

Keep Tracking spending Even When You Overspend

When tracking your expenses reveals that you overspent in a few categories, it can be tempting to get frustrated, stop tracking expenses, and start again the following month. However, it’s important to continue to track expenses throughout the month so you can identify what you need to change and by how much.

Once you get into the habit of tracking expenses, it will get easier and take less and less time to complete if you adopt an expense-tracking approach that works best for you and are consistent. Consistency in tracking your expenses will help you to be able to save more, spend less, and make the necessary changes to build wealth and reach your financial goals.

Final Thoughts on Tracking Expenses

At the end of each month, review the expenses you tracked and compare what you spent to what you planned according to your spending plan. If you overspent, look for ways to cut spending and if you spent too little, allocate more to your saving goals or debt repayment.

In either case, you’ll want to use what you learn from tracking expenses to make changes to the spending plan for the next month which will put you in a better financial position.

I dare you to track spending for a month or so. I mean really write down or in some other way, track every penny you spend and where you spend it. Once you do this, you will see places where you can spend less and save more. And you will see where you can change your behavior with money. Contact me if I can help you.

Three Reasons to Track Expenses

Three Reasons to Track Expenses

Tracking your expenses involves identifying and recording your expenditures throughout a specific period. It’s a crucial and basic activity that should ideally do done every day. 

It may seem like a lot of work to itemize your expenses when you decide to start using a spending plan. However, it’s important to understand why you need to track expenses and how to do so with minimal effort can help you successfully commit to tracking your expenses and becoming more aware of your spending.

Monitoring your expenses holds you accountable for your finances in a few ways. Below are three reasons to track expenses that will help you stay accountable.

It Helps You Stick to Your Spending Plan 

After you set up a spending plan, which is a plan for meeting expenses for a given time frame, tracking expenses is essential to keeping you on the right path with your spending plan and a reason to track expenses.

If you don’t track your money, you won’t know when to stop spending in each category like food for example. It is best to track expenses daily.

Tracking your expenses might reveal that your spending plan has too little for food or neglected to account for one-time or occasional expenses such as holiday spending. When you incorporate these infrequent expenses, you build a more realistic and comprehensive spending plan.

Something that you are more likely to stick with.

A spending plan is a living and breathing document that should evolve over time to suit your family’s needs and goals as they change. Recognizing that you are consistently overspending in one category or underspending in another can help you determine whether you need to make cuts or increases in that category for the next month’s spending plan.

Tracking Your Expenses Reveals Spending Issues

Tracking expenditures will make you more aware of your spending habits. If you don’t know where your money is going, you won’t be able to recognize negative spending habits and behaviors that can more easily be changed, and your money starting to work for you rather than against you.

For example, you might realize that your habit of dining out or buying clothing from expensive brands is causing you to run out of money before the month’s end. Tracking expenses can also help you identify problems in how you manage your money.

It Helps You Reach Your Financial Goals 

It’s not enough to stick to your spending plan if you don’t also make strides toward financial goals. Whether you set a goal to build an emergency fund or pay down debt, you’re more likely to achieve goals if you plan for them.

I dare you to track spending for a month or so. I mean really write down or some other way, track every penny you spend and where you spend it. Once you do this, you will see places where you are able to spend less and save more. And you will see, where you can change your behavior with money. Contact me if I can help you.

Tips for Reducing Financial Stress

If we are honest with ourselves sometimes our financial stress is caused by our expectations not being met. We want things to go one way with our finances and they go the other. Below are some tips for reducing financial stress in your life.

Losing a job, the inability to find full-time work, paying bills on time, and not being able to deal with the increasing costs of living can be disappointing.

When this happens, when our financial reality does not line up with our expectations, we can sometimes become stressed. Try the following tips to help you reduce your financial stress.

Set SMART Financial Goals to Reduce Financial Stress

Goals provide course of action. And financial goals provide direction for your financial matters. They should determine how you spend your time and your money. When setting goals, decide what you want, where you want to be, and what you want your money to do. Further, when you set goals, set goals that are SMART (specific, measurable, achievable, realistic, and have a time constraint).

The best goals are the ones that cause you to “stretch” as you do your best to reach them.

Make Your Time and Money a Priority

Use the “80-20 Rule” originated by Italian economist Vilfredo Pareto. The 80-20 rule says that “80 percent of the reward comes from 20 percent of the effort.” The key to prioritizing is to identify the valuable 20 percent.

Once identified, prioritize your time to work on the items with the greatest reward. If you value managing money well, prioritize the time it takes to manage it well. Knowing where you stand with your finances will help you reduce feelings of stress.

Take Some of the Stress Off and Be Flexible wIth Your Spending

According to Peter Drucker, a management consultant, author, educator, and the described father of modern management, “Doing the right thing is more important than doing things right.” Doing the right thing is effectiveness; doing things right is efficiency.

Be flexible when working on your money, focus first on the urgent, effective task, then concentrate on the important, efficient task.

Reduce Financial Stress by Planning To Spend Your Money

Using time to think and plan is using time wisely. Some would say that if you fail to take time for planning, you are, in effect, planning to fail. Additionally, be consistent with that time. If Monday after work is your money management time, then work your money Mondays after work.

As I have written before, managing money is a job, it takes time, so plan accordingly.

The tips for reducing financial stress above can help you reduce money stress in your life. Be careful with stress as it can cause mental, emotional, and physical health issues. How do you manage financial stress? I would love to hear from you.

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