What Is Debt-to-Income Ratio? How This Percentage Affects Lending & Credit Decisions

Your debt-to-income (DTI) ratio summarizes how much of your monthly income you use to pay off your debts. Issuers check this number to see if you’re a suitable candidate for a credit line. This ratio doesn’t affect your credit score directly, but it shows how well you manage your debts.

Simply put, lenders use your DTI ratio to judge your ability to comfortably pay your debts every month.

DTI is a straightforward number, but it has a few nuances you should know about. Let’s dive in to get a better feel for how it works. And don’t worry; the math is simple.

Components of the Ratio

The ratio’s two keywords are “debt” and “income.” For DTI, debt means any regular payments you need to make that you owe to a lender. This includes your monthly payments for credit cards, car loans, student loans, or any other money you have to pay back.

Your income for DTI purposes is all the money you collect each month before taxes. This includes your salary from jobs, any money you make from side jobs, and earnings from investments, all added together before taxes.

How to Calculate Your DTI Ratio

Figuring out your DTI ratio is easy. I’ll show you how, but you can also use online calculators or spreadsheets if you want help doing the math. 

Here are the steps:

1. Add up all your monthly debt payments. This includes your mortgage or rent, car loans, credit card payments, and student loans — just the regular debt payments you make each month. (Don’t count utilities, food, or other non-debt expenses.)

2. Figure out your total monthly gross income. That’s all the money you collect each month before any taxes or other deductions. Make sure to include all your different income sources.

3. Divide your total monthly debts by your total monthly gross income. For example, if your monthly debt payments are $1,250 and your monthly gross income is $3,650, your DTI ratio is $1,250 / $3,650 = 0.34 or 34%.

These are some typical income sources:

• Salary from Your Job: This is usually paid to you every two to four weeks, but other arrangements are possible
• Part-time Job Income: Money from working part-time or a side hustle
• Alimony: Money from an ex-spouse after a divorce to help you pay your living expenses
• Spousal Income: Your spouse’s income counts toward your household total, which is handy on joint credit applications
• Social Security Benefits: You can start collecting this at age 62, but the longer you wait (up to age 70), the bigger the monthly checks
• Disability Payments: This is money from the government or an insurance company when you can’t work because of an approved medical condition

The usual types of debts that most people include:

• Car Loans: If your family bought a car and is paying for it a little bit every month, that’s a car loan
• Credit Card Payments: When you buy things using a credit card, you need to pay back every month at least some of the money you charge
• Student Loans: Students often need to borrow money for college or trade school, which they must start paying back after they graduate 
• Mortgage or Rent: This is the money your family pays every month to live in a house or apartment
• Garnishments: If you owe money and haven’t been able to repay it, a court can order your employer to take money directly from your paycheck to pay off your debts
• Legal Judgments: This debt occurs when a judge or jury decides you owe money to someone.

These items represent different debts you must pay each month, and we use them to calculate your debt-to-income (DTI) ratio by comparing them to your monthly income.

Here are some tips to help you accurately calculate your debt-to-income ratio

• Gather All Your Monthly Debt Payments: Make a list of everything you have to pay each month that counts as debt. You can scan your recent bank statements to refresh your memory.
• Keep in Mind Less Common Debts: Remember to include other types of payments, such as alimony, child support, medical bills, insurance, garnishments, and legal judgments, as they are also part of your debts.
• Calculate Your Total Monthly Income: Add up all the money you make each month before taxes. Don’t leave anything out — include rent, royalties, annuities, and any other regular income you receive.
• Use Gross Income, Not Net: When calculating your DTI, make sure to use your gross income (before taxes and other deductions). This will give you a clear picture of your total earnings.
• Check Your Math: You should always verify you did the math correctly. Use a calculator or spreadsheet to make things easier.
• Update Regularly: Your finances evolve, so update your DTI ratio every few months to see how it is trending.

Do your best to get the numbers right so you can be as accurate as possible when corresponding with lenders.

Types of DTI Ratios and Their Uses

There are two main forms of the ratio: front-end DTI and back-end DTI. Lenders use them in different ways to get a picture of how you manage your money.

Front-End DTI

This ratio compares only your housing costs to your income. It includes your mortgage or rent. If you’re applying for a home loan, lenders look at this ratio to see if you can afford the new housing payments.

The common industry standard is that housing costs should be no more than 28% of gross monthly income. Many mortgage lenders follow this guideline.

However, for some types of mortgages, such as FHA loans, the lender may permit a higher ratio, up to 43% or even a bit more.

Back-End DTI

This ratio is broader. It includes all your monthly debt payments—not just housing. This means it adds up your mortgage or rent, car loans, credit card payments, and any other regular debts you have. Lenders use this ratio for all kinds of loans to see if you have too much overall debt compared to how much you earn.

Back-end DTI is important for many financial situations, such as when you want a new credit card, personal loan, or car loan. Lenders look at this ratio to decide if you’re already stretched too thin. For most loans, lenders prefer to see a back-end DTI of 36% or less. 

Understanding these types of DTI ratios helps you see how lenders view your finances and can guide you in managing your debts better, especially if you’re planning to borrow money for big purchases.

A high DTI ratio can hurt your ability to borrow money or get good terms for credit, because lenders use the ratio to help decide how much of a risk you pose. If you have too much debt compared to your income, it may look as though you’re having trouble making ends meet.

Too Much Debt Can Lead to Bad Credit

Your credit score doesn’t directly consider your DTI ratio, but it does look at things related to your debts. For example, it identifies how much of your available credit you use, which is also known as your credit utilization ratio.

Using a high percentage of your available credit limit can have a negative effect on your credit scores, including your FICO score.

Also, if you have a lot of debt payments, you could miss one, and this can significantly impact your credit scores.

A High DTI Ratio Can Make Credit Approval More Difficult

When you apply for new credit, lenders look at your DTI to see if you can afford to take on more debt. A high DTI ratio suggests you would have trouble managing another monthly payment. That can make lenders hesitant to approve your application.

Different lenders have different rules, but many prefer a DTI lower than 36% for standard credit cards. For premium cards with higher limits and benefits, the requirement can be even stricter.

A lower DTI ratio and a high credit score could help you get a higher credit limit and lower interest rates because they show lenders that you’re good at managing your debt. A high DTI can result in lower limits and higher rates, making borrowing more expensive.

Strategies to Lower Your Credit Card Debt

If you have a high DTI ratio, you can attack your credit card debt in several ways. In fact, the more methods you employ, the faster you can repay your debt and enjoy the resulting benefits.

Here are some popular and proven debt-lowering tactics:

• Pay More Than the Minimum: One simple way to reduce your credit card debt is to remit more than the minimum payment due each month. This helps you reduce the principal balance faster and save money on interest.
• Debt Snowball Method: Start with your smallest debt and pay as much as you can on it while making minimum payments on your other obligations. Once the smallest debt is paid off, move on to the next smallest. This method can give you quick wins and help keep you motivated.
• Debt Avalanche Method: First, focus on the debt with the highest interest rate. Pay as much as you can toward this debt while making minimum payments on the others. This method saves you the most money on interest over time because you’re tackling the most expensive debts first.
• Balance Transfer: Consider transferring your credit card balances to a card with a reduced interest rate, often called a balance transfer credit card. These cards offer a low or 0% introductory APR for a set period, which can help you save on interest while you pay down your balance. Be aware of balance transfer fees, and ensure you can pay off the debt before the promotional period ends.
• Consolidation Loans: Another option is to take out a debt consolidation loan. This is a lump-sum installment loan you use to pay off all your credit card debts. It leaves you with just one monthly payment. Ideally, the consolidation loan will have a lower interest rate than your credit cards, making it cheaper to pay off your debt.
• Stick Your Cards in a Drawer: To avoid accumulating more debt, take your credit cards out of your wallet and put them somewhere safe, like a seldom-used drawer. Using cash instead of credit makes unnecessary purchases less tempting and helps you stick to your budget. You can retrieve your cards after you pay off their balances.

You can tackle your credit card debt more effectively by using these strategies.

Moreover, keeping your DTI ratio low is good for your financial and mental health. It can also make it easier to get approved for credit when you need it, such as when you are buying a house or a car — and you’ll likely get better interest rates.

Best Practices for Credit Card Users

It’s really important to look at your credit card statements every month. This helps you see where your money goes and ensures there are no unexpected charges. Watch out for any charges you don’t recognize — these could be mistakes or even signs of fraud. 

Also, seeing your expenses in print may help you spot whether you’re spending money on things you don’t actually need.

Setting a budget for each month’s spending on your credit card is a smart way to control your expenses. Decide on an amount you can comfortably spend without making it difficult to pay off your full balance each month. This approach stops your card balance from increasing and saves you from paying extra interest.

Many credit card companies offer services that alert you about your spending. The issuer can notify you when you make a big purchase, get close to your credit limit, or for every transaction. These alerts help you monitor your spending and spot any unauthorized charges quickly.

Using tools and apps can also help you manage your credit card use. Programs such as Quicken are great for keeping track of your finances, including credit card spending. These tools let you see all your income and expenses in one place and identify how much you spend on your credit cards compared to your budget. 

Apps can be helpful for keeping an eye on your credit utilization ratio, which is the amount of your credit limit you’re using. There are tools to show how much you’re spending on your credit cards and how it compares to your budget. Keep an eye on your credit utilization ratio, which is how much of your credit limit you’re using — try to keep it below 30%.

Most banks now have mobile apps that track your spending and allow you to manage your accounts easily from your phone. These apps often provide insights into your spending patterns and can alert you when you near your credit limit.

There are many free online tools available that can help you calculate your credit utilization ratio. These calculators let you input your total credit limit and your current balances to see your utilization percentage. Understanding this number can help you take steps to manage it better.

Apps like PocketGuard and You Need a Budget (YNAB) help you create and stick to a budget. They can connect with your bank accounts and credit cards to give you a real-time view of your finances. These apps can also help you set goals for reducing your credit card spending and alert you when you spend more than you planned.

By using these tools and apps, you can get a clear picture of your credit utilization and overall financial health. They also provide the convenience of having all your financial information in one place.

When you apply for a loan, such as a mortgage for a house or financing for a car, lenders usually look at your DTI ratio to help decide if you’re likely to pay back what you borrow. A high DTI ratio means you’re using a lot of your income to pay off debts, which can make it tough to qualify for a loan and may result in higher interest rates.

Mortgages 

For home loans, lenders typically want your DTI ratio to be 36% or lower, though they may accept up to 43%. This means all your monthly debts, including your future house payment, shouldn’t require more than 43% of your pre-tax monthly income. Government-backed FHA loans may allow a DTI ratio as high as 50%.

Your DTI ratio influences your ability to get a mortgage and impacts the kind of interest rate and loan terms you might receive. If your DTI ratio is low, it indicates to lenders that you aren’t heavily burdened by debt, which can make you a less risky borrower. 

This can help you secure better interest rates and more favorable terms for your mortgage. Conversely, a high DTI ratio can make lenders wary, possibly leading them to offer higher interest rates to safeguard themselves in case you struggle with repayment. Remember, you risk foreclosure if you miss mortgage payments or eviction if you don’t pay the rent.

General takeaway: A 36% to 50% DTI ratio is required for mortgage approval.

Auto and Personal Loans

Most lenders will check your DTI ratio when you’re looking to buy a car or need a personal loan. This ratio helps them determine whether lending you money may be too risky.

For car loans, most lenders want your DTI ratio to be 40% or less. This means all your monthly debt payments, including the payment for a new car, shouldn’t be more than 40% of your monthly income before taxes.

Some lenders may be more flexible with auto loans because they can repossess the vehicle if you miss a payment.

Having a lower DTI ratio when you apply for an auto loan is key. It may make it easier for you to get approved for lower interest rates. But if your DTI ratio is high, lenders may charge you more in interest to make up for the bigger risk in lending to you.

General takeaway: Auto lenders prefer DTI ratios below 40% for loan approval.

Frequently, lenders who provide personal loans are more strict about DTI ratios. They usually prefer ratios to be below 36%.

Their strictness stems from the fact that unsecured personal loans don’t have any physical property, such as a car or house, to back them up. The loans depend solely on your promise to pay back the money.

Your DTI ratio plays a big role in whether you can get a personal loan and its terms. A lower DTI ratio shows lenders that you manage your debt well, which may encourage them to offer you better interest rates and easier repayment terms. 

However, a higher DTI ratio can make it tough to get a loan at all, and if you do get approved, you could face steep interest rates.

Reduce your DTI ratio before applying for auto and personal loans. This will boost your approval odds and may qualify you for better loan terms. 

General takeaway: Personal loan lenders prefer DTI ratios below 36% for loan approval.

Student Loans

Know your DTI ratio before you apply for a student loan for yourself or your kids. Your ratio is critical when you apply for a private student loan (but not so much for a federal loan). 

Federal student loans generally do not consider your DTI ratio when determining eligibility. This means you can often secure federal student loans even if your DTI ratio is quite high, making them a more accessible option for many students. 

On the other hand, if you’re applying for private student loans, lenders will likely review your DTI ratio. A low DTI ratio can help you qualify for these loans and may secure you better interest rates.

A high DTI ratio can impact your repayment options, especially with federal loans. If you have a high DTI ratio, consider repayment plans that allow you to make lower monthly payments. Be aware that these plans may increase the amount of interest you pay over the loan term.

Student loans can impact your DTI ratio for many years, as they often take a long time to pay off. Even after you graduate, having substantial student loans can keep your DTI ratio high and create an ongoing challenge if you try to qualify for other types of credit.

General takeaway: Federal student loans do not consider DTI ratios for loan approval.

It’s easy to make mistakes or get confused when you calculate your DTI ratio. That can be a big problem because the ratio helps lenders decide whether to give you a loan. Make sure you calculate DTI correctly to save yourself a lot of trouble. Doing it right can improve your chances of getting the credit you need.

DTI Miscalculations 

One big mistake to avoid is not adding up all your monthly debt payments correctly. You may need to include smaller loans or debts that don’t come up every month but still need to be paid, such as quarterly taxes or annual insurance premiums.  

Remember to include all your monthly debt payments, including credit card bills, car loans, student loans, and your mortgage or rent. But don’t count everyday expenses such as groceries, utilities, or your phone bill — lenders do not consider these to be debts.

Avoid using your net income (your take-home pay after subtractions) instead of your gross salary (your income before subtractions). Always use your gross income to make sure you calculate your DTI ratio correctly.

Some people think that only their regular paycheck counts as income. However, you should add in all other sources (e.g., bonuses, alimony, child support, and income from side jobs). Include all these in your total monthly income to lower your DTI ratio.

Understanding the Impact of Your DTI

Sometimes, people don’t realize how important their DTI ratio is until they face financial troubles. Monitoring your DTI ratio can help you avoid problems that come from borrowing more than you can afford.

An Example: Sarah’s Story

Here’s a story illustrating a common problem:

Sarah always paid her bills on time and thought she had her finances under control. When she wanted to buy a new car, she didn’t think twice about taking out a big car loan because she believed her income was enough to cover her debts. 

However, Sarah had yet to calculate her DTI ratio. She didn’t realize that with her new car payment, her DTI ratio would jump to 50%. Soon, Sarah needed help managing her monthly payments. She started using her credit card to cover other expenses and ended up with even more debt.

Just as with a yearly check-up at the doctor, it’s a good idea to review your DTI ratio regularly. Sarah learned the hard way that her financial health could change quickly. After her troubles, she started checking her DTI ratio every six months. This helped her see how debts compared to her income, allowing her to make smart decisions about spending and borrowing.

Preventative Measures

This list provides some actions you can take now to avoid DTI-related problems in the future:

• Set a Safe DTI Ratio Limit: Decide on a DTI ratio that you won’t go above, such as 35%. This will help you maintain a safe buffer and avoid overborrowing.
• Plan for Big Purchases: Before making large purchases that could increase your debt, look at how they would change your DTI ratio. If the purchase pushes your ratio too high, consider saving up more money before buying or choosing something less expensive.
• Build an Emergency Fund: Have savings to cover unexpected expenses so you can prevent the need to take on debt when surprises happen. Try to save up at least three to six months of living expenses.

You can avoid financial problems like those Sarah experienced by understanding the daily impact of your DTI ratio and taking steps to manage it. Regular checks and smart planning are key to keeping your finances running smoothly.

Artificially Lowering Your DTI Ratio

Some people try to lower their DTI ratio by not including all their debts when they apply for new credit These shell games may temporarily lower your DTI ratio in an application, but they don’t reduce the amount of debt you have.

By not addressing the real problem — too much debt — you may end up hurting yourself even more. Lenders may see you as a higher risk if they find out that you’ve been playing games to improve your DTI ratio. This could lead to higher interest rates on loans or even outright rejection.

Furthermore, managing debt can become very stressful. Over time, this strain can affect your financial decisions and emotional well-being. You also want to avoid imaginary income when you apply for a loan. Lenders use sophisticated tools to check your information.

They will likely reject any application that they can’t verify.

It’s a good idea to always be truthful about your debts when applying for loans. This helps ensure that any credit or loans you get reflect your actual financial situation.

If your DTI ratio is high, consider talking to a financial advisor instead of looking for quick fixes. An advisor can help you create a plan to reduce your debt over time.

Remember that lowering your DTI ratio is about improving your financial health, not just about qualifying for new credit. Work on long-term strategies like budgeting, reducing expenses, and paying off debts strategically.

You can keep your finances healthy by managing your debt responsibly and avoiding the temptation to artificially lower your DTI ratio. Doing so will help you build a stronger foundation for your financial future.

Your debt-to-income ratio helps you see how much of your income goes toward paying debts each month. A lower DTI ratio is better because it means you aren’t spending too much of your money on debt. This can help you manage unexpected costs with less stress.

Keeping track of your DTI ratio is important, especially if you want to borrow money for significant purchases such as a house or a car. Lenders look at your DTI ratio when they decide whether you can take on more debt and what interest rate you should pay. A good DTI ratio shows lenders that you manage your money well, which makes you eligible for loans with lower interest rates.