What’s a Good Debt-to-Income Ratio and Why Does It Matter?

If you take a look at qualifications for mortgages and other types of loans, you may stumble upon the acronym DTI — what does it mean? DTI stands for debt-to-income ratio, and it’s one of the most important factors that lenders review to determine whether or not borrowers qualify for a loan.

Since having a high DTI could make it harder to buy a house or a new set of wheels, it’s important to calculate your DTI to see where you stand, even before you’re ready to borrow.

Here, we explain what DTI is, why it matters, and what’s considered a good DTI.

What is a debt-to-income ratio?

Your debt-to-income (or DTI) ratio is a percentage that expresses how much of your monthly gross income goes to making monthly payments for housing expenses, consumer debt, and court-ordered debts.

Rent and monthly mortgage payments typically fall under the housing expense umbrella. Consumer debt may include minimum credit card payments and monthly loan payments. Obligations like alimony and child support fit under the court-ordered debt category.

Having a low DTI is good because it means you have fewer financial obligations and more cash to spare each month than someone who has a high DTI.

Why does your debt-to-income ratio matter?

Before giving you cash, lenders use your DTI to evaluate your eligibility for a loan. They want to be sure that you have the funds to keep up with your monthly payments. If a large part of your income already goes to other debt obligations, there’s a risk you may not be able to pay back their loan, and this can make banks, credit unions, and other financial institutions hesitant to lend to you.

There are two types of DTI ratios — front-end ratio and back-end ratio:

• The front-end DTI ratio compares just your projected housing expense (mortgage principal, interest, homeowners insurance, property taxes, etc.) against your monthly gross income. This ratio is typically only calculated when you buy a house.
• The back-end DTI is also calculated to approve you for a mortgage and other loan products, including personal loans and car loans. The back-end DTI compares all of your monthly debt payments to your gross income.

The limits for back-end DTI can vary depending on the type of loan you’re applying for and factors in your application. Here's a general rundown on potential requirements for different loan types:

• Car loan: 50% or less
• Personal loan: 40% or less
• Conventional mortgage (refinance or new loan): 43% or less
• FHA loan: 50% or less
• VA loan: 41% or less
• USDA loan: 41% or less

For front-end DTI, lenders typically want to see 28% or less. This could help you get the best mortgage rates.

If you’re thinking about buying a home and wondering how to get a loan, the first step is shopping around since credit and DTI requirements can vary from one lender to the next. FinanceBuzz’s review of the best mortgage lenders can help you compare options.

What’s a good debt-to-income ratio?

Here’s a breakdown of what’s considered good and not-so-good in terms of back-end DTIs:

• < 36%: Lower DTI ratio — you're likely able to manage your debt obligations comfortably.
• 36% to 41%: Decent DTI ratio — you may be able to qualify for a mortgage, car loan, or personal loan.
• 42% to 49%: Higher DTI ratio — lenders may start to view you as a credit risk. You might be able to qualify for a loan, though it's likely you'll get a higher interest rate.
• 50% or higher: Very high DTI ratio — you may have trouble keeping up with your bills, and lenders may want you to pay down debt before offering you a loan.

Even if you’re not applying for a home loan or car loan anytime soon, you could still benefit from keeping your DTI low. That's because having less of your income going to debt each month may mean you have the financial flexibility to save or invest more.

If your DTI is too high, you might struggle to make monthly debt payments, which can make budgeting difficult. It could affect your ability to work toward other financial goals, like saving for retirement.

What factors impact your DTI ratio?

Your gross income plays a key role in the calculation of your DTI ratio. The second factor that affects your DTI is the different types of monthly debt obligations you might have. These are the types of payments that generally factor into the calculation of your DTI ratio:

• Rent or mortgage payments
• Minimum credit card payments
• Alimony payments
• Child support payments
• Auto loan payments
• Student loan payments
• Personal loan payments
• Wage garnishments
• Any other loan or debt payments

How to calculate your DTI ratio

Even if math isn’t your forte, DTI calculations aren’t too difficult. Here are the steps:

1. Add up all of your monthly gross income (money earned before taxes or other deductions)
2. Add up all your housing and debt payments for the month
3. Divide the sum of your debt payments by your total gross monthly income
4. Multiply that result by 100 to get a percentage

To calculate your front-end DTI, you follow the same steps above except you only include your monthly housing expense instead of your total debt payments.

For example, let’s say your gross monthly income is $5,000, and your monthly housing expenses are $1,000. In this case, your front-end DTI would be 20% ($1,000 divided by $5,000).

If you wanted to calculate your back-end DTI, you could also add up your total monthly debt payments. Let's say your car payment, credit card payments, and student loan payments totaled $750 per month. If you add that to your monthly housing costs, your total monthly expenses are $1,750. In this case, your back-end DTI would be 35% ($1,750 divided by $5,000).

If you prefer not to do the math by hand, you could also calculate your DTI using one of many online debt-to-income calculators.

How to lower your DTI

Say you want to buy a house or car, and your DTI is higher than necessary to qualify. Taking these steps could help you lower your DTI:

• Focus on paying down credit card debt and use credit sparingly going forward.
• Make extra loan payments to pay off your loans faster, or consider a payoff strategy like the debt avalanche or debt snowball method.
• If you have student loans, joining an income-driven repayment (IDR) plan could lower your monthly student loan payment. Just keep in mind that lowering your payment could also cost you more over time.
• Try to increase your income by considering a part-time job, asking for a raise, applying for a promotion, or accepting a job with a higher salary.

FAQs

Bottom line

If you plan to apply for a loan sometime in the future, calculating your DTI and taking steps to lower it could help you get approved. DTI requirements can vary for different loans, but in general, a good rule of thumb is to try to keep your DTI below 43%.

If you have no plans to borrow money, lowering your DTI could still benefit your personal finances. By lowering your debt obligations and monthly bills, you could free up cash to meet other goals, such as stashing more money into a retirement fund, opening a 529 plan for your child’s college education, or growing your vacation fund balance so you can take a big trip.

You may be able to reduce your debt balances by making extra monthly debt payments. A small sum put toward your debt might not seem like much, but those payments can add up and make a more significant dent in your debt.