Your debt-to-income ratio, or DTI, compares your debt payments to your income on a monthly basis. It’s an important measurement of how manageable your monthly budget is, as it reveals how much of your income is being devoted to payments on debt you still owe.
But it’s even more important to be aware of your DTI if you’re planning to apply for new credit soon. Here’s what you need to know.
How debt-to-income ratios work
A debt-to-income ratio is expressed as a percentage that represents how much of your monthly income goes toward debt repayment. So a DTI of 20%, for example, shows that your monthly debt costs are equal to 20% of your gross monthly income.
The lower your monthly debt costs and the higher your income, the lower your DTI. But if you borrow more or your income is lower, your DTI will be higher.
There are two types of debt-to-income ratios that a lender might consider.
Your front-end DTI compares your total housing or mortgage costs to gross monthly income. It’s sometimes also called your housing-expense-to-income ratio. This is based on your full mortgage payments if you have a mortgage, and would include principal, interest, property taxes, homeowners association fees and insurance costs. If you rent, it would be your monthly rent amount. It doesn’t include non-fixed costs such as utilities.
Your back-end DTI compares your income to the minimum payments on your outstanding credit accounts, including mortgage and non-mortgage debt. That means your back-end DTI includes:
- Monthly payments on installment loans such as student loans, car loans or personal loans
- Housing expenses, such as monthly rent or full monthly mortgage costs (as outlined above)
- Minimum monthly payments on revolving accounts such as credit cards or lines of credit
- Other financial obligations such as child support or alimony
Your back-end DTI is more commonly considered by lenders when you submit a loan application. A mortgage application will usually consider both your front- and back-end DTIs when deciding if you qualify.
Because a back-end DTI is more commonly used, assume that we’re referring to this number unless otherwise noted.
Why lenders favor applicants with lower DTIs
Most lenders will also consider your DTI to decide if you can reasonably afford to take out and repay an additional debt. A low DTI tells them that you have room in your budget to take on and repay new debt, increasing your chances of getting approved for credit. But a high DTI could be a red flag to lenders that you’re already stretching yourself thin and pose a larger lending risk.
If you’re planning to apply for a home loan, car loan or other types of credit, it’s important to figure out your debt-to-income ratio. Knowing your DTI will clarify whether you’re likely to qualify for new credit, or if you need to take steps to compensate for a poor ratio.
Even if you aren’t planning to take out a loan soon, maintaining a healthy DTI can be a good idea. It’s a sign that you’re managing your finances well and avoiding taking on more debt than you can afford, and it will also make it easier to get a loan in an emergency or unexpected event.
What is a good debt-to-income ratio?
As you take stock of your debt payments and income, you might be wondering how good a debt-to-income ratio needs to be. When lenders assess your loan application, what is a good DTI?
While DTI standards can vary by lender and product, some general rules can help you figure out where your ratio falls. Here are some guidelines about what is a good debt-to-income ratio:
- The “ideal” DTI ratio is 36% or less. At least, that’s the common financial advice of the “28/36 rule.” This guideline suggests keeping total monthly debt costs at or below 36% of your income, and housing costs at or below 28%. (You can calculate this number for yourself by multiplying your monthly income by 0.36 or 0.28). A DTI in this range will result in affordable debt and give you the ability to qualify for additional credit when needed.
- The maximum DTI for most lenders is 43%. This is typically the threshold for getting a new loan, according to the Consumer Financial Protection Bureau. Borrowers with a debt-to-income ratio exceeding 43% are shown to be more likely to struggle with monthly costs. You’re much less likely to get approved for a loan with a DTI above 43%, and might need to seek alternative products.
- The maximum front-end DTI ratio for a home loan is 31%. At least, that’s the rule set by the Federal Housing Administration for loans it guarantees. Most lenders will want to see that the total costs of your new FHA mortgage payment are equal to or less than 31% DTI. For non-FHA loans, the guideline is a front-end DTI of below 28%, according to the National Foundation for Credit Counseling.
- The lower your DTI, the better. As mentioned, a high ratio of debt to your income could be a sign that you can’t afford to take on more debt. So the lower your DTI, the better — while a 36% ratio is good, a 20% DTI would be viewed even more favorably.
How to calculate your debt-to-income ratio
Now that you know what is considered a good debt-to-income ratio, it’s time to calculate your own. Here’s a step-by-step process to calculate your DTI.
- Look up all your monthly debt costs. To figure out your debt-to-income ratio, you’ll need an accurate dollar amount of every debt you pay each month. Find the monthly minimum payments for your mortgage (or rent, if you don’t own a home), student loans, car loans, credit cards and other financial obligations.
- Add your monthly payments together. Add up the dollar amounts of all these monthly payments to get the total you pay toward these each month. (If you want to figure out your front-end DTI, include only your housing-related costs.)
- Figure out your monthly income. You’ll need to use your gross income, and include all income sources, including overtime pay, bonuses and pay from a second job or side hustle. A salaried employee can divide annual income by 12 to find monthly income. If you’re hourly or your pay fluctuates, review recent pay stubs to figure out your typical monthly income.
- Divide monthly debt costs by your monthly income. This will give you a decimal figure, which, if you multiply by 100, is your debt-to-income percentage.
If you follow these steps, you can calculate your DTI. Here it is as a mathematical formula:
(Sum of all monthly debt payments / Gross monthly income) * 100 = Your debt-to-income ratio
You can also use a calculator to automatically generate your DTI. We like the straightforward DTI calculator from our sister site Student Loan Hero, which generates both your front-end and back-end ratios.
How to improve your debt-to-income ratio
After running the numbers on your debt-to-income ratio, you might be worried that yours is too high. Fortunately, you do have some control over your DTI and, with some time and effort, could decrease it.
The way to do that is to work on the two things that factor into this ratio: your income and your debt costs. Here are some ways you can work on each of these to improve your debt-to-income ratio.
1. Avoid taking on more debt
Any new debt you accrue will only push your DTI higher. If you’re already uncomfortable with how high your debt-to-income ratio is, that’s a sign that you need to stop borrowing until you get it under control.
Take a look at your budget to ensure you’re living within your means and not spending more than you’re making. If you’re used to spending with credit cards, consider putting these away and paying only with debit cards or cash. Save up for major purchases or emergencies, too, so you can rely on your funds instead of borrowing to cover upcoming or surprise expenses.
2. Pay off low balances first
Every time you pay off a debt completely, you eliminate the monthly payment from your budget. So making extra payments on some of your credit accounts could be a smart way to lower your monthly costs.
This can be especially effective if you follow the debt snowball method, which targets your lowest balance first to quickly eliminate your smallest debt. Each time you pay off a loan or credit card, you’ll get rid of a monthly payment and lower your DTI in the process.
On top of decreasing your DTI, following the snowball repayment method will also get you out of debt faster and save you money that you’d have otherwise spent on interest.
But if you’re looking to get out of debt faster by reducing your total interest costs so that more of your monthly payments go toward the principal balance, you could opt for debt consolidation. With debt consolidation, you can take out a personal loan to pay off existing debts. The new loan should have a lower interest rate.
Debt consolidation could also help your DTI ratio by lowering your monthly payment. If you choose a longer repayment term, your monthly payments may decrease, which positively affects your DTI ratio. But a lower monthly payment may mean you’ll be in debt longer.
If you want to explore debt consolidation loan options, you can try out LendingTree’s personal loan tool. You’ll fill out basic information about yourself, your finances and what you need out of a loan. Then you may receive loan offers from lenders you can review.
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3. Refinance your debt
Another smart strategy to lower your monthly debt payments is refinancing. When you refinance debt, you use a new loan to pay off and replace a previous loan. Doing so gives you a chance to get a loan with terms, costs and payments that are a better fit for your needs.
Here are the main ways that refinancing student loans, a mortgage, credit cards or other debt can help lower your monthly debt costs and, in turn, your DTI.
You can refinance to a lower rate. Your monthly debt payments will include a payment to both your principal, as well as an interest charge. The former goes toward lowering your balance, while the latter is an additional cost you pay in exchange for borrowing these funds.
The interest costs are based on your interest rate. Refinancing can be an opportunity to replace a high-interest debt with a new, lower-interest loan. This, in turn, can help lower your monthly debt costs.
You can refinance to a longer loan term. Since refinancing means getting a new loan, it could also give you the chance to choose a longer loan term. This stretches out your debt repayment over more monthly payments, so you pay less each month.
Say, for instance, you bought a home with a 15-year mortgage but have found yourself uncomfortable with how high your monthly payments are. You could consider refinancing to a 30-year mortgage to decrease your mortgage payments and lower your DTI.
As you consider refinancing, watch out for potential downsides as well. Switching to a longer loan term will increase the total interest you pay over the life of the loan, and refinancing can also trigger new loan fees or closing costs. Weigh the benefits and drawbacks for your situation to see if refinancing makes sense.
4. Earn more at your day job
While it’s important to pay attention to your debt, don’t overlook the other side of the DTI equation: your income. One of the most effective ways to lower your debt-to-income ratio is to increase how much you earn at your day job. Here are a few strategies that can make that happen:
- Pick up more hours. If you’re not full time, ask your manager for an extra shift or offer to cover for your co-workers. Even full-time workers can sometimes pick up overtime to boost pay, so check with your manager for such opportunities.
- Work toward a raise. Has it been a while since your pay was bumped or have you taken on new responsibilities? Do you have other reason to think you’re underpaid for your work? Start a conversation with your manager about your pay to see if you can negotiate a pay raise now or set a performance track to qualify for one.
- Seek higher-paying jobs. Switching to a new company can be one of the best ways to get a big pay increase. Do some research into your local job market to figure out what you’re worth and uncover employment opportunities to pursue.
5. Start a side hustle
Use your off-hours to earn more with a second job or side hustle. This can help you generate more income that can be included when calculating your DTI. As a bonus, this additional pay can be the perfect source of funds to pay your debt off faster.
Here are some side hustle ideas to consider:
- Pick up an hourly second job. You can get a range of part-time jobs in your time off, from teaching a fitness class to tutoring on the side or waiting tables.
- Consider freelancing, consulting or coaching. If you have specialized skills, you can apply them after hours and get paid a premium to do so.
- Try a money-making app. You’ve heard of Uber and Lyft — and might have considered driving for them yourself. But these aren’t the only ways to make money from apps. You can use apps to earn extra money baby-sitting, pet-sitting, cleaning houses, renting out your spare car or room or delivering groceries or takeout to make extra income.
6. Look for ways to offset your DTI
If you can’t or don’t want to wait for your DTI to decrease to apply for a loan, you might still have options. Some mortgage lenders will grant you a loan with a debt-to-income ratio over 43% if you can compensate in other areas of your financial history. One way is by having large cash reserves on which you can fall back.
Applicants who can qualify on their own can also add a cosigner to their application. You and your cosigner will be equally responsible for repaying this debt, and both your incomes and DTIs will be considered as well. Adding a qualified cosigner could help you surpass DTI requirements that you couldn’t meet on your own.
Lastly, you can work to optimize other factors considered on credit applications to improve your approval chances. Building your credit to achieve a good score, for example, can go a long way toward offsetting a higher debt-to-income ratio.
Your DTI is an important measure of your health that should matter to you as much as your credit score or reports. Check in on your debt-to-income ratio whenever it might have changed, such as after paying off a loan or working a side hustle for a few months. Tracking your progress can highlight how far you’ve come and keep you motivated to continue working on your DTI.
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