Practical Guide to Improving Your Debt-to-Income Ratio

See a guide to improving your debt-to-income ratio

Did you know that the ratio between debt and income is one of the main indicators of a person’s financial health? That’s right! You should know that this ratio is important, especially when it comes to assessing your ability to pay your obligations.

Improving this ratio means taking measures to reduce debt or increase income, in order to balance personal finances and avoid problems such as default or economic difficulties. Want to know more? Then read on to find out practical strategies that can be adopted to improve the relationship between debt and income!

1. Understanding the debt/income ratio

The debt/income ratio (also called the debt-to-income ratio) is a calculation that compares the total amount of debt with the person’s or company’s disposable income. This ratio is used as a tool to measure a person or organization’s ability to repay their debts.

For example, if a person has a total debt of R$30,000 and a monthly income of R$5,000, their debt/income ratio is 6, i.e. they have a debt equivalent to six times their monthly income.

A high debt/income ratio, such as values above 3, can indicate that the individual or company is financially overburdened, which can lead to difficulties in paying off debts and obtaining new credit. However, a balanced ratio (generally below 1) suggests a more stable financial situation.

2. Reducing debts

In principle, the first approach to improving the debt/income ratio is to reduce debts. This is because there are various ways of doing this, and the choice of method depends on the person’s financial profile. But what can we include in this practice? Some strategies include:

• Consolidating debts: in many cases, combining several debts into a single loan can make repayments easier and reduce interest. Consolidation allows the individual to pay a fixed amount each month, possibly with lower interest rates than they were paying separately;
• Renegotiation of debts: for those who are already struggling to pay, negotiating directly with creditors can be a good solution. Renegotiation can result in longer terms, discounts on interest and even a reduction in the value of the debt;
• Avoiding new debts: the unbridled use of credit, such as personal loans, credit cards or the financing of durable goods, is one of the main causes of increased debt;
• Extra payments: whenever possible, setting aside part of the budget for extra debt payments can speed up the repayment process and reduce the amount paid in interest in the long term.

3. Increase your income

On this list, we can’t leave out increasing income either. This is because, as well as reducing debts, another effective way of improving the debt/income ratio is to increase income.

So for that, there are a few options you need to consider, which include the alternatives below!

• Salary increase or promotion: negotiating a salary increase or seeking a promotion within the company can be a way of improving income on a permanent basis;
• Extra income: looking for alternative sources of income can be a solution to increase debt repayment capacity;
• Investments: Investing strategically can generate financial returns that help balance the budget. Looking for a diversified investment portfolio, with shares, real estate funds and other options, can generate passive income that increases disposable income.

4. Review spending and cut expenses

One of the simplest ways to improve your debt/income ratio is to review and cut unnecessary spending.

Keeping track of monthly spending and making a detailed budget is essential. With a clear view of your finances, you can identify where resources are being misdirected and reallocate them to paying off debts.

In addition, reviewing fixed expenses, such as subscriptions to services, cell phone plans, insurance and even electricity use, can result in considerable savings. Often, simple changes, such as switching phone plans or looking for cheaper alternatives for essential services, make a big difference.

It’s worth noting that in addition to fixed costs, controlling spending on items such as food, leisure and shopping is also fundamental. Switching consumption habits for more economical alternatives can free up resources for paying off debts and saving.

5. Use financial planning and advice tools

Managing personal finances can sometimes be complex, especially in situations of severe debt. In such cases, enlisting the help of financial tools such as spreadsheets, budgeting apps or even the advice of a financial expert can be a good way to improve the debt/income ratio.

Specialized professionals can help you draw up an effective payment plan and advise you on the best strategies for paying off your debts quickly and efficiently.

Improving your debt-to-income ratio is an important step towards ensuring sound financial health. Reducing debts, increasing income and controlling spending are fundamental strategies for achieving financial balance.

Finally, it is worth emphasizing that with dedication and planning, it is possible to turn the debt/income ratio into an advantage, allowing for a more stable and secure financial life.

Escrito por

Juliana Raquel