Debt-to-income ratio (or DTI) is an important indicator of your financial health. It calculates how much of your monthly income goes toward paying current debt (including mortgage and rent payments).
Lenders may use your DTI to determine their risk in lending to you. In other words, your debt-to-income ratio is a measure of your creditworthiness.
In general, the more you pay to service your existing debt, the less confident lenders will be in your ability to keep up with the payments on any new debt. The less debt you have compared to your income, the more likely it is that lenders will trust you to safely manage new debt.
What is included in a debt-to-income ratio?
Your debt-to-income ratio compares your monthly bill payments to your gross monthly income. It accounts for all monthly recurring debt and expenses, such as housing, credit cards, and other loans.
How do I calculate my debt-to-income ratio?
To estimate your DTI, you can use an online debt-to-income calculator or pencil and paper.
First, gather your bills. You will need to include any of the following payments that apply:
- Full mortgage payment (including principal, interest, taxes, insurance, and any homeowner association fees) or rent payment
- Car payment
- Student loan payment
- Personal loan payment
- Minimum required payments on all credit cards or lines of credit
- Child support or alimony payments
- Any other monthly debt obligations
Then, figure out your monthly gross household income from employment and other documented sources of income, such as self-employment. Your gross income would be your total earnings before taxes and deductions. For your household, it would include the gross income of all earners. Be sure to include all sources of income, including wages and any additional sources of income.
Your debt-to-income ratio is the total amount of all these monthly expenses divided by your gross income. (You don’t need to include your discretionary spending or things that fluctuate such as your gas bill or groceries.)
For example, if your total monthly debt payments come to $2,500 and your gross monthly income is $7,000, your DTI would be 36%.
Why does DTI matter?
Your DTI is important because it gives an immediate snapshot of your financial situation.
If your DTI is too high, you might struggle to cover your daily expenses, let alone save for important financial goals.
In addition, your DTI ratio can make the difference between loan approval and rejection because it’s a strong indicator of whether you can afford to add new payments to your monthly budget.
A high DTI could make it more difficult to qualify for a mortgage, car, or other kind of loan.
Many personal finance advisors believe that everyone should work to lower their DTI by eliminating most debt other than a mortgage or rent payment, and perhaps a car payment. Reducing your debt can give you more flexibility and freedom, and set you up for a rewarding future.
You could start by consolidating higher-interest debt from credit cards into a fixed-rate, fixed-term personal loan. You might be able to pay off your debt faster and save money on interest.
What is a good debt-to-income ratio?
Ideally, you want your DTI to be as low as possible because that indicates that your income is well above what you need for recurring expenses.
If you’re applying for a personal loan, lenders typically want to see a DTI of 35% to 40% or less. But they might allow a higher DTI if you also have good credit or other compensating factors, like a savings account large enough to cover several months of living expenses.
What does my DTI mean?
According to Credit.org,1 if your DTI is:
- 35% or less: You probably have a good amount of income each month to put toward investments or savings. Most lenders will think you can safely take on monthly payments for a new loan or line of credit.
- 36% to 43%: You have acceptable levels of debt in relation to your income. Still, some lenders may want you to reduce your DTI ratio further before they approve you, especially for a larger loan amount or if they have strict lending standards.
- 44% or more: You are carrying high levels of debt relative to your income. Lenders might not be convinced that you will be able to pay for another loan.
Can I lower my DTI?
To change your DTI ratio, you will need to reduce your debt payments, increase your income, or do both.
For example, if you find that your DTI is too high to qualify for the loan you want, start by looking at what you spend and what you owe. Look at your net income and monthly expenses. Where can you save? Are your adult kids still on your cell phone bill? Do you have a streaming service or gym membership you’re not using? Can you make your coffee at home? You’d be surprised by how impactful paying attention and making small tweaks to your spending habits can be.
If you have higher-interest debt, you could save money by consolidating those bills into one fixed-rate personal loan with a set regular monthly payment. If you get a personal loan at a lower interest rate than you had been paying, you will reduce your overall debt load and lower your DTI.
How can I reduce high-interest credit card debt?
Credit cards are a convenient way to pay for daily expenses and they can help you build credit. But the average APR for credit cards was 24.54% in July 2023.2 So if you find yourself struggling to keep up with your payments, it may be time to rethink how you manage this type of debt.
It’s never a bad idea to reduce any debt you have at a higher interest rate. Paying your credit cards off monthly is a great way to keep revolving debt low. If that’s not always possible, try to pay a bit more than the minimum each month. If your higher-interest debt becomes unmanageable, you can consider a personal loan for debt consolidation.
Be sure to compare interest rates, repayment terms, and the monthly payment amount to determine what is the best debt consolidation tool for your financial situation.
For example, if you get approved for a $15,000 personal loan with a 12.99% APR and a term of 72 months, you will pay just $301 a month.
Now imagine you have the same amount in credit card debt. With a 20% APR and a minimum payment of 3% of the balance per month, it would take you roughly 25 years to completely repay the balance owed, including accrued interest in the amount of approximately $18,360.
Even if interest rates fluctuate, your personal loan will be locked at a fixed rate which won’t increase over the life of your loan—and that could help you stick to your budget and lower your DTI.
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