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Whether you’re shopping for a mortgage or applying for a new line of credit, you’ve likely heard the term debt-to-income ratio mentioned. Your debt-to-income ratio, or DTI, tracks how well you can manage debt based on your income, then expresses it as a percentage.
But what does that mean – and why does it matter to potential lenders? This guide breaks down the definition of DTI, how to calculate it, and why the ratio impacts your finances.
Your DTI ratio compares the amount you owe each month (aka your debts) to the amount you make each month. Essentially, your DTI ratio measures how well you manage debt. It also helps lenders determine if you can safely borrow more money.
If your DTI ratio is on the low end, you may be able to handle more credit, such as a mortgage or personal loan. But if it’s higher, you may not have the financial bandwidth to take on more debt.
How to calculate your debt-to-income ratio
To calculate your DTI ratio, divide your monthly debts by your gross monthly salary. Then, multiply that number by 100 to express it as a percentage. (You can also use an online debt-to-income ratio calculator to determine how much of your income goes toward your monthly bills.)
Debt-to-income (DTI) ratio formula
Monthly debts / Gross monthly X 100 = Debt-to-income ratio (%)
For example, imagine you spend $2,000 on debts each month. Your pre-tax monthly salary is $5,000. You would calculate your DTI ratio as follows:
DTI ratio = $2,000 / $5,000 = 0.4
DTI ratio = 0.4 x 100 = 40%
DTI ratio = 40%
In this scenario, 40% of your income goes toward paying off debts, leaving the remaining 60% for other expenses.
The formula is relatively straightforward. However, determining your total monthly debt payments and your monthly gross income isn’t always easy. Let’s take a closer look at what makes up your DTI ratio and how creditors determine your ability to manage more debt.
Factors that affect your debt-to-income ratio
Many creditors consider two types of DTI ratios to determine if you can take on more debt: front-end ratios and back-end ratios.
A front-end ratio is also known as a housing ratio. Front-end ratios calculate the percentage of your income that goes toward housing expenses and includes:
- Monthly mortgage payments or rent
- Property taxes
- Homeowners insurance
- Homeowners association (HOA) fees
Back-end ratios consider both housing expenses and other monthly debt payments, such as:
- Credit card payments
- Student loans
- Auto loan payments
- Personal loan payments
- Child support
These and other forms of long-term debt are combined to calculate your total monthly debts. But remember, these ratios don’t include all monthly bills. For example, utility bills, car insurance payments, cell phone bills, and health insurance costs aren’t considered when calculating your DTI ratio.
With that in mind, it’s important to consider the full scope of your monthly expenses before taking on additional debt.
What is a good debt-to-income ratio?
The Consumer Financial Protection Bureau (CFPB) recommends maintaining a DTI ratio of 36% or lower.² Individual lenders may have different guidelines for borrowers.
For instance, mortgage lenders backed by the Federal Housing Administration (FHA) may require you to have a front-end DTI ratio of 31% or less.³ A personal loan provider may allow you to have a higher DTI ratio since many people use personal loans for credit card refinancing and debt consolidation.
How can I lower my debt-to-income ratio quickly?
Lowering your DTI ratio can be done in two ways: by increasing your income or paying off existing debt. Either way, it requires some careful planning.
Consider the following ways to start reducing your DTI ratio:
- Create a budget. Tracking your expenses and making a budget are the best ways to improve your financial habits and pay off debt. Catalog every expense – even the small ones – and look for ways to divert more funds toward your debt.
- Don’t take on more debt. Avoid taking on more debt unless necessary. That means limiting credit card purchases, avoiding new credit applications, and not taking out any additional loans. Doing so will increase your balance and could impact your credit score.
- Make payments on your existing debt. Prioritize making payments on existing debt. Even if you can only make minimum credit card payments alongside your mortgage, car payment, and other expenses, you’ll start chipping away at your balances.
Why is debt-to-income ratio important?
DTI ratio is important because it’s a measure of your financial well-being. A low DTI ratio indicates you can manage your existing debt and may be comfortable accessing additional credit.
On the other hand, a high DTI ratio may signal financial strain. If a significant part of your monthly salary goes toward debt payments, you may not have the financial bandwidth for more credit.
Does debt-to-income ratio affect my credit score?
Your DTI ratio won’t directly affect your credit score. That’s because the major credit bureaus – Experian®, Equifax®, and TransUnion™ – don’t use your income when calculating your credit score.
Instead, credit reporting agencies consider your credit utilization rate. Credit utilization compares your available credit with the amount you’re using. For example, if your credit card has a $2,000 limit and you currently owe $500, your credit utilization rate would be 25%.
A high credit utilization rate can cause your rating to drop. But working to lower your credit utilization ratio by paying down debt can improve your credit score – and lower your DTI.
What is the difference between a good debt-to-income ratio and a bad one?
A “good” DTI ratio usually falls below the Consumer Financial Protection Bureau’s (CFPB) 36% benchmark. However, DTI ratio limits may vary based on the type of loan or credit you need and the lender you choose.
Will paying off my credit cards lower my debt-to-income ratio?
Paying off your credit cards may lower your DTI ratio if you don’t take on additional debt. By paying off your credit card balances, you’ll reduce the money you pay toward debt each month, effectively lowering your DTI ratio and credit utilization rate.
Is my mortgage included in my debt-to-income ratio?
Mortgage payments, homeowners insurance, homeowners association fees, and property taxes are included in your DTI ratio. If you rent a home, rent payments are also included. Other housing-related expenses like gas, electricity, cable, and water bills aren’t included in your DTI ratio.
What is a good debt-to-income ratio to buy a house?
The CFPB recommends maintaining a mortgage DTI ratio of 28% to 35% for homeowners.² Your home loan payments shouldn’t cost more than 35% of your gross monthly income.
When applying for a loan or mortgage, make it a priority to keep your DTI ratio as low as possible. Some lenders will consider borrowers with DTIs as high as 43%, but most look for a back-end DTI ratio of 36% or lower.
Keep tabs on your DTI ratio
Like your credit score, your DTI ratio is a simple, effective measure of your financial health. Your DTI ratio goes beyond rating your financial habits and estimates how comfortably you can manage existing and new debt.
By getting familiar with your DTI ratio, you’ll have a better idea of whether or not you might get approved for additional credit. Knowing your DTI ratio can also empower you to improve financial health, like paying off debt or prioritizing savings.
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