What Is a Good Debt-to-Income Ratio?
Learn why debt-to-income ratio is important and how to calculate and improve yours
When you’re applying for a new credit card, looking into a mortgage or simply talking with an expert about your finances, you might hear the term “debt-to-income ratio” or “DTI ratio” for short. So what does debt-to-income ratio mean? And why does it matter?
Keep reading to learn more about the meaning of DTI ratio, how to calculate your own ratio and steps you can take to improve it.
What Is Debt-to-Income Ratio?
Simply put, debt-to-income ratio is how much debt you have compared with how much income you have. It’s typically expressed as a percentage. Think of it as what you owe vs. what you earn. It’s basically a snapshot of how much of your monthly budget is taken up by debt payments.
So why does debt-to-income ratio matter? For one thing, your DTI ratio is one way to look at your overall financial health, according to the Consumer Financial Protection Bureau (CFPB). The CFPB also says that having a DTI ratio that’s too high could affect your ability to get approved for new credit.
Your debt-to-income ratio can help lenders determine whether you can manage additional monthly payments and how likely you are to repay a loan on time. Keep in mind that lenders might look at many other factors, like your credit scores, too.
How to Calculate Debt-to-Income Ratio
Learning how to figure out your debt-to-income ratio takes a little basic math:
- Step one: Add up all your monthly debt payments. That can include things like your mortgage, student loans, auto loans, credit card payments and personal loans. And if you have court-ordered payments like alimony or child support, those count too.
- Step two: Figure out your gross monthly income. This is the amount you earn every month before things like taxes, insurance and Social Security are taken out. Don’t forget to include any court-ordered payments you receive. If your income varies, the CFPB recommends estimating what a typical month’s income would be.
- Step three: Divide your total monthly debt payments by your gross monthly income.
- Step four: Multiply your answer by 100 to get your debt-to-income ratio as a percentage.
Don’t worry if it’s still a little confusing at first. Here’s an example so you can see how it works:
If you pay $200 a month for an auto loan and $200 for your student loans, your total monthly debt is $400. And if, for example, your gross monthly income is $2,000, that would mean your DTI ratio equation is: 400 divided by 2,000 = 0.2. Then, multiply 0.2 by 100 to get your DTI ratio as a percentage. In this example, it’s 20%.
The CFPB also has a debt-to-income ratio calculator if you want some help figuring out your DTI ratio.
What’s a Good Debt-to-Income Ratio?
What’s considered a good debt-to-income ratio depends on your unique situation. But the CFPB does offer some general guidance.
For homeowners, the CFPB recommends keeping your DTI ratio for all debts—including your monthly mortgage payment—at 36% or less. The CFPB also notes that 43% is typically the highest DTI ratio you can have for a qualified mortgage.
For renters, the CFPB recommends trying to keep your DTI ratio for all debts at 15%-20% or lower. And the CFPB says not to include your rent payment when calculating your DTI ratio for this purpose.
If you’re struggling to keep your DTI ratio at or around these guidelines, the CFPB recommends reaching out to a U.S. Department of Housing and Urban Development counselor for help with housing issues.
How Can I Improve My Debt-to-Income Ratio?
Here are few things to consider if you’re working on your debt-to-income ratio or learning how to use credit wisely:
- Avoid taking on new debt. “Avoiding debt can help build your financial well-being,” says the CFPB. And because your DTI ratio depends on your amount of debt versus your income, taking on more debt without growing your income will increase your DTI ratio. So it’s a good idea to apply only for the credit you need and avoid unnecessary new debt.
- Pay down existing debt. There are a few different strategies for paying off debt. The CFPB talks about the snowball and highest-interest-rate methods. But there are many more strategies—like consolidating debt—that you might explore too. Before you make any decisions, consider talking to a qualified financial professional to figure out a debt management plan that works for your specific situation. You might even have access to some financial planning services through your employer or retirement plan administrator.
- Pay more than the minimum. The CFPB recommends paying more than the minimum payment on your credit cards whenever possible. This may help you reduce your credit card debt faster and minimize credit card interest charges. It can also help your credit utilization ratio, which can be an important factor in calculating your credit scores.
- Use a budget. The CFPB says that making and sticking to a budget is an important step toward getting your debt under control. They even provide a budget worksheet to help you get started. You might also consider learning more about how to budget with a credit card.
Monitor Your Credit for Free With CreditWise From Capital One
Monitoring your credit can help you understand more about how your financial habits impact your credit. And it can help you track your progress as you work to pay off debt and improve your credit score.
CreditWise from Capital One can help. CreditWise is a free tool that allows you to access your TransUnion® credit report and VantageScore® 3.0 credit score—without hurting your score. And it’s free for everyone, not just Capital One customers.
You can also visit AnnualCreditReport.com to learn how you can get free copies of your credit reports from each of the three major credit bureaus.
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