Maybe you’re looking to apply for a new credit card, or talking with an expert about your finances, and you hear the term “debt-to-income ratio.” What does it mean? And why does it matter to you? While your debt-to-income ratio may not be a major factor in your credit score, it can affect whether you get credit—and it’s an important number when you’re balancing what you owe with what you earn.
Q: What is debt-to-income ratio?
A: Simply put, it’s how much debt you have (what you owe) compared with how much income you have (what you earn). Your total debt might include things like student loans and car loans in addition to credit card balances.
Q: Why does it matter?
A: When you want to borrow money—by applying for a credit card or taking out a loan, for instance—your debt-to-income ratio is one of the parts of your credit history that lenders look at. It helps them see how you might manage future payments, and that can determine the interest rates they offer you.
Q: How can I figure out my debt-to-income ratio?
A: It takes a little basic math. First, add up all your monthly debt payments. Next, you need your gross monthly income—the amount of your monthly paycheck before things like taxes and Social Security are taken out. Divide your total monthly payments by your gross monthly income and you’ve got your ratio.
Q: What’s a healthy debt-to-income ratio?
A: What you spend on debt—including your mortgage or rent, car loans, student loans and credit card bills—should be no more than 36% of your income.
Q: How can I improve my ratio?
A: Earning more and having less debt will get you closer to a healthier debt-to-income ratio. And reducing your debt starts with spending more responsibly:
- Pay more than the minimum: Whenever possible, try to pay more than the minimum listed on your credit card statement. It may help you reduce the credit card portion of your debt faster.
- Use a budget: As you set a plan for your expenses, be sure to factor in your debt payments. You might also consider how to budget with a credit card.