When you apply for a loan or line of credit, you can expect lenders to evaluate your creditworthiness. That’s where your debt-to-income ratio (DTI) comes in. It’s a snapshot of your financial bandwidth, showing how much of your monthly income is currently being used to pay off debt and other obligations, and it’s important for getting approved for all kinds of loans.
What is your debt-to-income ratio?
Your debt-to-income ratio is what your debt obligations look like relative to your entire income. A lower ratio means you have a greater capacity to take on more debt—while a higher DTI may suggest that your budget doesn’t have much room for more debt obligations. Keeping your DTI on the lower side can make it easier to qualify for new lines of credit.
There are 2 main kinds of DTI: front-end and back-end. Front-end DTI considers only your housing costs, expenses such as mortgage payments, property taxes, and homeowners insurance. Back-end DTI, on the other hand, includes all of your monthly payments—housing costs plus payments for student loans and credit cards, for example.
How does your debt-to-income ratio work?
Your DTI works as a standard screening tool for lenders. They often use this metric to clarify how much of your income is currently going toward debt payments. That can help them determine how much flexibility you have to take on new accounts. Lenders consider DTI when deciding:
- Whether to approve a credit application.
- How much to lend you.
- What interest rate to offer you.
Why is your debt-to-income ratio important?
Your debt-to-income ratio is important because lenders use it to evaluate applications for loans, such as mortgages and auto loans. Having a high DTI could mean you’re financially overextended, which can limit your borrowing options. Your credit score could also suffer if you have a high DTI. That’s because utilization ratio, or how much of your available credit you use, is a factor in calculating your credit score—and utilization ratio is a similar metric to debt-to-income ratio. Budgeting carefully and knowing how much debt you can realistically handle can allow you to stay on track.
How to calculate your debt-to-income ratio
To calculate your DTI, follow these steps.
- Add up your total monthly debt payments.
- Divide that amount by your gross (pretax) monthly income.
Debt-to-income ratio example
For example, let’s say your total debt payments come to $3,000 and your gross monthly income is $6,500. Your DTI would be about 46%.
What’s included in your debt-to-income ratio?
Below are the factors that are typically included in the DTI formula.
Debts
- Housing costs
- Mortgage/rent
- Homeowners insurance
- Property taxes
- Homeowners association fees, maintenance fees, and/or common charges
- Revolving debt (loans that allow borrowing up to a limit until payments are received)
- Minimum credit card payments
- Home equity loans
- Home equity lines of credit (HELOC)
- Installment loans (loans with fixed monthly payments)
- Auto loans
- Student loans
- Personal loans
- Cosigned loans
- Other mandatory payments
- Child support owed
- Spousal support owed
Income
- Wages from an employer
- Self-employment income
- Retirement income, including Social Security benefits and pensions
- Rental property income
- Disability benefits (in some cases)
- Child support received
- Spousal support received
- Repeated investment income from interest and dividends
What’s excluded from your debt-to-income ratio?
Not all types of expenses count toward your DTI, especially ones that could change from month to month. The following are typically left out of the calculation.
Excluded debt and income
- Health insurance and medical bills
- Retirement contributions
- Monthly utilities
- Car insurance
- Cellphone bills
- Internet and cable/streaming service bills
- Groceries
- Child care expenses
What is a good debt-to-income ratio?
A good debt-to-income ratio is 36% or lower. Just know every lender is different, and it varies by loan type too. In some cases, lenders may consider a DTI that exceeds 50%, but that could result in a higher interest rate and/or fees. Here are strong DTI ratios based on different needs.
What is a good debt-to-income ratio for buying a home?
Mortgage lenders generally prefer a back-end DTI that’s below 43%, but it may be possible to qualify with a higher DTI. For example, some government-backed mortgages allow for DTIs as high as 50%, assuming the borrower has plenty of cash savings and a healthy credit history.
What is a good debt-to-income ratio for getting a car loan?
A debt-to-income ratio less than 36% is best, though some lenders may be willing to go up to 50% or even more.
What is a good debt-to-income ratio for renting an apartment?
Landlords often prefer a DTI of 36% or lower. However, renters may get approved with DTIs up to 49% in some cases.
What is a good debt-to-income ratio for opening or increasing a credit card limit?
Credit card issuers generally prefer a DTI of 35% or lower, but you may still have options if yours is higher—you might just need to meet extra eligibility requirements.
How to potentially lower your debt-to-income ratio
To potentially reduce your debt-to-income ratio, try taking the following steps. All together, they could allow for greater financial flexibility, minimize borrowing costs, and make you more likely to qualify for new loans.
1. Review your monthly debts and income
Begin by clarifying how much you’re currently paying each month toward debt and other obligations. Now calculate your DTI to see where you stand. This can give you a starting point to work with.
2. Limit new credit card use
Avoid increasing your balances or taking on new credit accounts while you work to improve your DTI.
3. Make more than your minimum payments
Paying down balances is one of the best ways to reduce your debt-to-income ratio. Targeting high-interest debt can also save you money in the long run. Review your budget to see how much debt you can reasonably afford to erase each month.
4. Consolidate or refinance loans
This involves combining multiple debts into one new loan to reduce your interest rate and streamline your monthly payments. If interest rates fall or your credit improves, you might consider refinancing for a lower rate.
5. Increase your income
If debt is one side of the coin, your income is the other. Earning more—whether that’s through a raise, bonus, or side hustle—can help improve your debt-to-income ratio, even if your financial commitments stay the same. Easier said than done, but it could be worth exploring these 10 ways to make more money.