What Is a Good Debt-to-Income Ratio?
Your debt-to-income (DTI) ratio is how much money you earn versus what you spend. It’s calculated by dividing your monthly debts by your gross monthly income. Generally, it’s a good idea to keep your DTI ratio below 43%, though 35% or less is considered “good.”
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What is a good debt-to-income ratio?
As a general rule of thumb, it’s best to have a debt-to-income ratio of no more than 43% — typically, though, a “good” DTI ratio is below 35%. Your DTI ratio is made up of two parts:
- Front-end ratio: Sometimes referred to as the “housing ratio,” your front-end ratio refers to what part of your income goes toward housing costs. This can include rent or mortgage payments, homeowners or renters insurance and property taxes.
- Back-end ratio: This refers to the percentage of your income that goes toward all of your monthly debt obligations, including housing. This can cover your car loan, credit card bills and student debt.
Your DTI ratio helps creditors determine whether you can afford new debt. It plays a major role in your creditworthiness as lenders want to make sure you’re capable of repayment. Each lender will have its own criteria around what DTI ratio you can have to qualify for credit.
Debt-to-income ratio of 35% or less
The lower your DTI ratio, the more positively lenders may view you as a potential borrower. A DTI ratio that’s below 35% indicates to lenders that you have savings and flexibility in your budget — it may also indicate that you have a good credit score, though this isn’t always the case.
Debt-to-income ratio of 36% to 49%
If you have a DTI ratio between 36% and 49%, this means that while the current amount of debt you have is likely manageable, it may be a good idea to pay off your debt. While lenders may be willing to offer you credit, a DTI ratio above 43% may deter some lenders.
Debt-to-income ratio of 50% or more
If you have a DTI ratio that’s over 50%, you might be in some financial hot water. It may be wise to seek solutions like credit counseling to help you better manage your debt. A credit counselor can enroll you in a debt management plan and work with your creditors to lower your rates and monthly payments.
Debt-to-income ratio for mortgage
Mortgage lenders pay extra attention to your DTI ratio when it comes to buying or refinancing a home. They scrutinize both your front-end and back-end DTI ratios, and could deny your home loan request if you carry too much debt compared with your income.
The Consumer Financial Protection Bureau (CFPB) suggests consumers cap their back-end DTI ratio at 43%; however, you shouldn’t rely on that to qualify for a mortgage. Lenders don’t consider expenses like family cell phone plans, car insurance for a new teenage driver or that college tuition bill coming up in a few years — avoid taking on a payment that’ll squeeze your budget.
DTI ratio requirements usually range between 41% and 50% depending on the loan program you apply for. The guidelines tend to be more strict if you’re taking out a conventional loan versus a mortgage backed by a government agency, like the Federal Housing Administration (FHA) or U.S. Department of Veterans Affairs (VA).
How to calculate debt-to-income ratio
To calculate your debt-to-income ratio, follow this step-by-step process:
- Add up your monthly debts, like your rent or mortgage, car loan, credit card bills and student loans.
- Calculate the gross monthly income you bring in — this is how much money you bring in before taxes and deductions. You can figure your gross monthly income by:
- Dividing your annual gross salary by 12
- Multiplying your hourly wage by 40 for the number of weeks you work, then multiplying that figure again by four for your monthly income
- Lastly, divide the total monthly debts you have by your gross monthly income. This will provide your DTI ratio.
Let’s say that each month, you have a $1,500 rent payment, $400 auto loan bill, $200 student loan bill and a $50 credit card bill. Totaled together, this adds up to $2,150 along with a gross monthly income of $5,000.
Here’s what that would come out to: $2,150 ÷ $5,000 = 43% DTI ratio.
In addition, here’s what your front-end and back-end debt-to-income ratios would look like:
- $1,500 ÷ $5,000 = 30% front-end DTI ratio
- $2,150 ÷ $5,000 = 43% back-end DTI ratio
Debt-to-income ratio mortgage calculator
Also known as a home affordability calculator, a DTI ratio mortgage calculator can give you a quick glimpse of what you can afford. You’ll need to have a rough idea of your monthly debt payments (credit cards, car loans, student loans) and how much of a down payment you’ll want to make.
Follow these steps to calculate how much home you can afford based on your DTI ratio:
- Enter your annual income. Remember, this should be how much you make before taxes and deductions.
- Add up and enter your monthly debt. A helpful qualifying tip: In the case of credit cards, only add up your minimum monthly payments (even if you pay extra).
- Down payment. The higher your down payment, the lower your mortgage payment and DTI ratio will be.
- Loan term. A longer term (30 years is the most common) will give you the lowest monthly payment and DTI ratio.
- Pick your DTI ratio preference. LendingTree’s home affordability calculator is set to a 28% DTI ratio, but you can slide the bar up to 50% to see how much more house you’d be able to buy if you can afford the higher monthly payment.
If you’re not sure whether you can afford a home just yet, you can do some simple math to gauge where your DTI ratio is:
- Choose the monthly housing payment you’d feel comfortable making
- Add your monthly debt to the monthly mortgage payment
- Divide the total by your monthly before-tax income
- The result is your current DTI ratio
The example below puts these numbers in action, assuming you make $6,250 per month, have $400/month of debt and would like to keep your mortgage payment at $1,750 per month.
|Add up your total debt
|$1,750 + $400 = $2,150
|Divide the debt by your before-tax income
|$2,150 ÷ $6,250 =
|The result is your current DTI ratio
How to lower your DTI ratio for a mortgage
If your DTI ratio is too high for loan approval, consider some of these options:
- Make a higher down payment: Some options to obtain a higher down payment include saving for a bit longer, asking a relative for a gift or taking out a 401(k) loan.
- Higher credit score: To boost your score, pay off credit card debt and avoid opening new credit accounts so you get the lowest possible mortgage rate and payment.
- Stockpile some savings: Lenders may approve your loan with a higher DTI ratio if you can prove you have mortgage reserves to cover your payment if you hit a financial rough patch.
- Shop for cheaper homeowners insurance: Your homeowners insurance premium has a direct impact on your mortgage payment — the lower it is, the lower your DTI ratio is.
- Get a cosigner: Most mortgage programs allow you to borrow with someone else, even if they don’t plan to live in the home. Just make sure they understand they’re on the hook for the payment if for any reason you fall behind.
- Buy a multifamily home: If you don’t mind being a homeowner and a landlord, you can buy a two- to four-unit home and use the rental income on the unit you don’t live in to reduce your DTI ratio.
Can your debt-to-income ratio impact your credit?
Your debt-to-income ratio isn’t recorded on your credit report, so it won’t directly impact your credit score. However, a high DTI ratio could indicate that you have a large credit utilization ratio, which will impact your credit score.
Credit utilization ratio is how much debt you have divided by the amount of credit you have access to. For instance, if you have a credit card with a $800 balance and a $2,000 limit, then your credit utilization ratio is 40%.
Your credit utilization ratio plays one of the largest roles in determining your credit scores. With the FICO Score model, credit utilization makes up 30% of your credit score. When it comes to your VantageScore, your credit utilization ratio is 20% of your credit score.
How your debt-to-income ratio affects you
Even though your debt-to-income ratio doesn’t show up on your credit report, it can still affect you if you try to borrow money:
- Prevents you from taking out new credit: If you have a high DTI ratio, lenders may be cautious about lending you money. You may get denied for any new loans or revolving credit you apply for since you come with more of a risk in the eyes of lenders.
- Costs you more money: If you have a high DTI ratio, lenders may view you as a riskier borrower. As a result, you may have to pay more in fees and higher interest rates. For instance, when buying a house, you may pay more in closing costs or end up with higher interest rates. In addition, a DTI ratio over 45% requires that you take out private mortgage insurance (PMI), which increases your DTI ratio even more.
- Limits how much you can borrow: A high DTI ratio limits your budget when it comes to taking out new debt. For instance, a large DTI ratio limits how much you can spend on purchasing a house. To determine how much of a mortgage loan you can qualify for, use a home affordability calculator.
How to lower your debt-to-income ratio
A high debt-to-income ratio can inhibit you from new credit opportunities. If you want to lower your DTI ratio, consider the following strategies:
- Aggressive monthly payments can cut down on your DTI ratio as long as you have the flexibility in your budget to do so. Two such strategies are the debt avalanche method — which advises consumers to pay off debts with the highest interest rates first — and the debt snowball method — which encourages consumers to pay off their smallest debts first.
- Decreasing your mortgage payments can help reduce the cost of your largest monthly expense. You can lower your mortgage payment by using strategies like refinancing, getting a longer loan term or switching to an adjustable-rate loan.
- Debt consolidation is the process of rolling all of your debts into a single personal loan. A debt consolidation loan can lower your monthly payments as long as you can qualify for a lower annual percentage rate (APR) or get a long loan term.
- Credit card refinancing involves moving your debt to a balance transfer credit card, ideally with a 0% intro APR. While you can only do this with credit card debt, it can be a helpful way for you to save money — you can focus on paying down your balance, rather than interest, for the first few months.
- Credit counseling is a low-cost strategy to get professional help to cut down on your debt. Credit counseling won’t hurt your credit and allows you to enter into a debt management plan with your creditors. A debt management plan can help you pay off your debt within three to five years.