Your debt-to-income ratio (DTI) is an important number when applying for loans.
Lenders look at this ratio to help them determine how likely you are to be able to make the monthly payments.
Keeping your DTI under 36% will give you the best chance of getting a new loan with favorable interest rates.
Erika Taught Me
- Your debt-to-income ratio is a percentage of how much of your gross income is being used to make monthly debt payments.
- Credit cards, mortgage, rent, child support, and alimony can all be included as monthly obligations.
- A DTI under 43% (and ideally under 36%) is best.
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How Does Debt-to-Income Ratio Work?
Your debt-to-income ratio is the relationship between how much income you have and the debt payments you owe each month. It's calculated as a percentage of your income before taxes that goes towards paying down debt.
It also includes your rent, child support, and alimony. While these are technically not debts, they are still monthly obligations you must pay.
The point of this ratio is to determine how much of your income is going to prior obligations. Lenders will use this number to help them determine how much new debt you can afford to take on.
What is a good debt-to-income ratio?
Lenders like to see a DTI ratio of 43% or less.
This is the highest DTI you can have and still qualify for a conventional mortgage, but many lenders prefer to see a DTI under 36%.
When your DTI is under 36%, you’re considered a safe bet — someone who will likely be able to handle the payments on a new loan. You'll have a good chance of qualifying for a favorable interest rate, too.
If you have a ratio between 36% and 41%, you are considered to have manageable debt, but you may have trouble getting larger loans that would push your DTI into unhealthy territory. You may also see higher interest rates.
If you have a ratio between 42% and 49%, you are getting onto dangerous grounds. Lenders will have concerns that you won’t be able to meet any new debt obligations. You may have to pay off some debt before taking on a new loan, and will likely see higher interest rates.
If you have a ratio over 50%, you will have trouble getting a new loan because lenders will believe you are unable to meet your current debt loads.
READ MORE: What Is the Credit Utilization Ratio and How Does It Affect Your Credit?
How To Calculate My DTI
To calculate your DTI, add up your monthly payments, including your rent, and divide that total by your gross monthly income.
For your debts, you'll want to include:
- Monthly mortgage or rent payment
- Monthly child support or alimony payment
- Student loans payments
- Car payments
- Credit card minimum monthly payment
- Any other monthly debt payments
For your gross income, look at your pay stub and locate your income before taxes.
- If you are paid twice per month, multiply your gross income by two to get your monthly income.
- If you are paid every other week, multiply the gross income listed on your paycheck by 26 and then divide by 12 to get your monthly income.
- If you are paid weekly, take your gross weekly pay and multiply it by 52, then divide by 12 to get your average monthly income.
Once you have your monthly obligations and your gross monthly salary, you can figure out your DTI. Simply take your monthly bills and divide them by your monthly salary.
For example, let's say you had $2,000 a month in bills and $4,000 a month in gross salary. The calculation would be:
$2,000 / $4,000 = 0.5
Multiply that by 100 to convert it into a percentage. In this case, the DTI would be 50%.
READ MORE: Average Savings by Age Group: How Do You Compare?
How To Lower DTI
There are only two ways to lower your debt-to-income ratio: by paying off some of your debts or increasing your income.
While there are different ways to pay off debt, you may want to consider using the debt snowball to attack your debts. This method is especially helpful when it comes to DTI since it aims to pay off any small debts right away, which can remove those minimum payments from your ratio.
Increasing your income may be harder without changing jobs or taking on a new one. Could you negotiate your salary at work to earn some extra income? Maybe your performance review is coming up or there’s a new position available.
Or, if you can manage it, a side hustle is another way to increase your income. You can use the extra money to reduce your debts — which will in turn help lower your DTI.
Keep in mind that if the side hustle is not something you can maintain long-term, beware of taking on too much debt. Calculate your DTI without your side hustle income to make sure you are staying in healthy ranges.
READ MORE: How To Pay Off Credit Card Debt
FAQs
What if my debt-to-income ratio is too high?
If your DTI is too high, aim to lower it by paying off debts, so you can remove those minimum monthly payments from your calculations.
How much debt can you have to buy a house?
For most lenders, your debt-to-income ratio must be under 43% to qualify for a traditional mortgage. This ratio is calculated using your new mortgage, not your current mortgage or rent.
What debt-to-income ratio is needed for a car loan?
Exactly how much risk a lender is willing to take on will depend on the specific lender. However, a DTI under 36% would be considered a safe ratio for most lenders.
As your DTI increases, you may find you will pay a higher interest rate, and as it reaches 50%, you may not qualify at all.
Does your debt-to-income ratio affect your credit score?
No, your DTI does not affect your credit score because your income is not included on your credit report. However, lenders can use the information in your credit report, along with your income, to help them calculate your DTI ratio.
TL;DR
Your debt-to-income ratio is what lenders use to decide whether to lend you money. They take your monthly income before taxes and divide that by the amount of monthly debts you’re currently paying.
You want a DTI under 36% for the best chance at loan approvals and the lowest interest rates. If your DTI goes above 43%, you’ll likely struggle to find loans with good terms.
For more debt management and budgeting advice, check out these episodes of the Erika Taught Me podcast:
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