Debt-to-income ratio reflects the percentage of your gross monthly income, or earnings before taxes and other deductions, used to pay your monthly debts. Lenders use your debt-to-income, or DTI, ratio to evaluate your ability to manage the money you have borrowed and determine your capacity to take on additional debt, such as a mortgage or a personal loan.
A low DTI ratio tells lenders you have a good balance between income and debt, and a lower default risk.
Read on to learn what a good DTI ratio is, how to calculate your DTI, and how you can improve it.
What Is a Good DTI Ratio?
A good DTI ratio is no more than 43%, but less than 36% will improve your chances of borrowing money at an affordable rate. Generally, the lower your DTI ratio is, the better. It indicates that, even after covering your bills, you have income available to repay new debt.
DTI requirements and limits depend on the lender and the loan product. But DTI ranges fall into these common categories by percentage:
| DTI ratio | Range | What borrowers can expect |
| 51% or higher | High | With more than half of your income going to debt, you will likely have trouble qualifying for most loans. |
| 44% to 50% | Moderate | You may struggle with credit approvals or be limited in how much you can borrow. |
| 37% to 43% | Fair | You’re doing OK but should prioritize paying down debt to better handle unexpected expenses. |
| 36% or less | Good | Congratulations! Your debt is manageable, and you shouldn’t have trouble getting approved for more credit. |
Note that lenders use not only DTI to evaluate your creditworthiness, but also your credit score and history.
[Read: Best Personal Loans.]
How to Calculate Your DTI Ratio
You can calculate your DTI ratio by adding up all of your monthly debt payments and then dividing the total by your gross monthly income. Include these monthly debt payments in your calculation if they apply:
— Mortgage.
— Personal loans.
— Minimum credit card payments.
Some lenders also allow rent, alimony and other monthly obligations. But many monthly payments for household expenses, such as utilities and groceries, are not included in your DTI ratio because they are not debts.
For your credit cards, make sure you include only the minimum payment for each account and not the entire balance.
“People often get confused and think it’s the total amount of money you owe on your debts,” says Bill Maurer, director of the Institute for Money, Technology and Financial Inclusion at the University of California, Irvine. “It’s what you have to pay each month compared to what you receive each month.”
Let’s say your gross monthly income is $7,000, and you have a $1,500 mortgage, a $700 car payment and $150 in minimum credit card payments for a total of $2,350 in monthly debt obligations. Divide that debt sum by the gross monthly income and your DTI ratio would be about 34%. In other words, 34% of your income each month goes toward debt in this scenario.
[Read: Best Bad Credit Loans.]
Why Does Your DTI Ratio Matter?
Your DTI ratio matters because it’s a key factor that lenders use to determine whether you can borrow money and what rate to charge.
“If you have a low DTI ratio, the lender won’t worry about what you’re adding,” Maurer says. “Your DTI ratio gives a pretty good sense of the amount of additional payments you can add in your month and still keep your head above water.”
Knowing your DTI ratio can help you evaluate your financial health even if you’re not applying for credit.
“A solid debt-to-income ratio is an important indicator for overall financial well-being,” says Ohan Kayikchyan, a certified financial planner and economist.
A high DTI ratio can prevent you from qualifying for a mortgage or financing a car. Spending too much of your income on debt can also leave little for savings or emergencies. You can run into more trouble if you start to fall behind on minimum payments, with late fees and dings to your credit.
Does Your DTI Ratio Affect Your Credit?
Your DTI ratio isn’t part of your credit report or credit score, but you still need to monitor it. Lenders may calculate your DTI when you apply for credit and evaluate it to determine your eligibility. A low DTI can show you’ll have enough money to take on a new payment.
That makes your DTI ratio just as important as your credit score for good overall credit health.
[Read: Best Debt Consolidation Loans.]
How to Lower Your DTI Ratio
If you have room to improve your DTI ratio, you can try these strategies:
— Increase your income. This can be done by working overtime, taking on a part-time job or side hustle, or negotiating a raise with your employer. You can find many ways to increase your income, but keep in mind that some may not be possible or practical.
— Pay off debt. This is the simplest way to reduce your DTI quickly. Start with your highest-interest debt first and then work your way down.
— Refinance your debt. If you have high-interest debts, you may be able to refinance them. A debt consolidation loan, home equity loan or line of credit, cash out refinance, or balance transfer credit card can help you reduce your monthly payments and overall debt.
— Reduce your expenses. Cutting your spending will free up more income to pay down debt. You can carve out savings on your cellphone plan, pause or cancel subscriptions and memberships, and skip restaurant or takeout meals, for example.
— Stop taking on new debt. Avoid applying for loans or credit cards, running up your card balances, and making major purchases while you work on your DTI.
A mortgage payment that you can’t comfortably afford can also make your debt hard to manage. You should have enough left after paying the mortgage to cover other living expenses, savings and discretionary purchases.
Consider downsizing if your mortgage is too much to handle, Maurer says.
Adds Kayikchyan: “Make sure you own your house, not that your house owns you.”
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What Is Debt-to-Income Ratio? originally appeared on usnews.com
Update 05/12/23:
