What is a good debt-to-income ratio? Calculate your DTI ratio

Your debt-to-income ratio mirrors how well you manage and pay down your debts. Whether you’re applying for a loan or mortgage or aiming for financial stability, you may be curious, “What is a good debt-to-income ratio?”

To help secure your financial goals, we outline what a debt-to-income ratio is, how to calculate your DTI ratio, and how to lower it.

What is a debt-to-income ratio? 

When you apply for credit, you may wonder what your DTI ratio is and how it affects your chances. Your debt-to-income (DTI) ratio basically captures the percentage of your monthly gross income that goes to your monthly debt payments. Along with your creditworthiness, lenders use this ratio to gauge your capability to manage and pay off debts. 

Though lenders vary in their DTI requirements, a lower DTI ratio generally means you’re in good financial standing. It consists of two components: 

• Front-end ratio: Your front-end ratio is the percentage of your income that goes to housing costs, like rent or mortgage, insurance, property taxes, and more.
• Back-end ratio: The back-end ratio takes into account your housing expenses plus any other monthly debts. These consider your revolving debts, like car loans, credit card bills, student loans, etc.

With that in mind, maintaining a low debt-to-income ratio is important to obtain credit and favorable terms. 

How to calculate your debt-to-income ratio? 

To calculate your debt-to-income ratio, you can easily follow these 4 simple steps.

Step 1: Add all your monthly debts

Get the sum of your monthly payments – mortgage, student loans, auto loans, credit card debts, personal loans, etc. If you have any court-ordered payments, like alimony or child support, don’t forget to also include them. Say you pay $1,316 for your monthly mortgage, $276 for student loans, $513 for an auto loan, and $115 for credit card bills. This means your monthly bill is $2,220.

Step 2: Assess your gross monthly income

After that, check your gross monthly income, which is your income before deductions like taxes and insurance. Ensure you include any court-ordered payments you receive. If your income varies, estimate an average monthly income. For example, if your gross monthly income is $6,128, you use this amount for the calculation.

Step 3: Divide

Once you get both numbers, divide your total monthly debt payments by your gross monthly income. Taking the examples above, divide $2,220 by $6,128. This means your debt-to-income ratio is around 0.36.

Step 4: Multiply

You then multiply it by 100 to convert the ratio into a percentage. In our example, the debt-to-income ratio would be 36%.

What is considered a good debt-to-income ratio?

Even if lenders have different DTI standards, ideally, you should keep a low debt-to-income ratio. But usually, here’s a breakdown of different ratios and their implications:

Debt-to-income ratio of 50% or more 

If your ratio is more than 50%, it shows that more than half of your income goes toward your debts. Meaning you may struggle to meet your monthly payments. That said, lenders can see this as a red flag and limit your borrowing options. 

Debt-to-income ratio of 42% to 49%

Falling within this range may cause some concerns about your borrowing capacity. This level of debt suggests almost half of your income is allocated to your debt payments. If you’re trying to get a loan, try to lower your DTI ratio first to prove you can handle another loan. 

Debt-to-income ratio of 36% to 41%

This level of debt is considered manageable, but it’s still important to keep it in check. Though if you’re looking for larger loans with stricter lending criteria, consider paying off your existing debts. Through this, you can reduce your DTI ratio and increase your chances of qualifying for a loan.

Debt-to-income ratio of 35% or less 

A ratio below 35% shows that your debt payments are manageable. With lower debt obligations, lenders see you as low risk and may likely extend a new loan or credit to you.

Does your debt-to-income ratio impact your credit score?

In short, no. Your debt-to-income ratio itself does not appear on your credit report. Credit reporting agencies don’t include your income in your credit score, so your DTI ratio doesn’t directly affect your credit score. 

Still, a high DTI ratio means you have a high credit utilization ratio. Your credit utilization ratio represents your outstanding credit balance divided by your maximum available credit. This ratio then accounts for 30% of your credit score. With that said, a low credit utilization ratio leads to a low debt-to-income ratio, too.

Lenders consider your debt-to-income ratio alongside your credit score when you apply for a loan or credit. So, even if it doesn’t directly impact your credit score, your debt-to-income ratio influences your chances of getting approved for a loan. 

What’s a good debt-to-income ratio to buy a house?

When you plan to buy a house, lenders pay attention to your DTI ratio to assess if you can meet your monthly mortgage payment. Different lenders set different limits. But ideally, a debt-to-income ratio lower than 36% shows you can handle monthly debt obligations. 

Though it’s possible to get a mortgage with a DTI ratio of 43%, it doesn’t guarantee loan approval. As a rule of thumb, you lift your chances of qualifying for a mortgage if you have a lower DTI ratio. 

Typically, conventional loans have stricter DTI requirements you must meet. On the contrary, mortgages backed by government agencies tend to have lower DTI limits. These mortgages may be from the Federal Housing Administration (FHA) or the U.S. Department of Veterans Affairs (VA). 

How to lower your debt-to-income ratio

Don’t worry if you find yourself with a high debt-to-income ratio. Here are some steps you can take to lower it.

Track your bills

Pay close attention to your income and expenses. Take note of how much you earn and spend in a month. This, in effect, will give you a clearer idea of your situation. And once you gauge where you stand, you can carefully plan your next moves.

Create a budget

You can then set a budget that matches your financial goals. Look for costs you can reduce or cut, like subscriptions, dining out, memberships, etc. Remember though to stick to your budget so that you can save more. 

Pay your current debts

Use the extra funds you save to pay off your outstanding debts. Think about paying off smaller balances first, such as credit card bills. After that, you can move on to higher debts until you settle all your outstanding balances. 

Avoid more debts

Extra debts only increase your DTI ratio and set you a step back. So, even if it may be tempting, try to steer clear of credit card purchases. Also, avoid applying for new loans before managing your DTI ratio.

Explore your options

Find ways to lower your payments. These can include talking to your credit card provider to lower the interest on your credit card debt. You may also try consolidating your debts to lower your interest rate and easily manage repayments.  

Final thoughts

In a nutshell, a good debt-to-income ratio is the key to building your financial position and lifting your chances of getting a loan. With that in mind, aim for a lower DTI ratio by budgeting, paying down current debts, and avoiding new credit. Remember, achieving a good debt-to-income ratio is a significant step toward gaining control of your finance. 

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