What is a debt-to-income ratio?
A debt-to-income ratio is the percentage of your monthly gross income that goes toward paying your monthly debts. Lenders use DTI as one factor when reviewing a loan application by considering both front-end and back-end debt ratios. Popular among lenders to use when it comes to installment loans.
Your front-end DTI is the percentage of your monthly gross income that goes toward paying your housing expenses, like your mortgage or rent, homeowners insurance and property taxes.
Your back-end DTI is the percentage of your monthly gross income that goes to all other debts, like car loans, credit cards and student loans.
Both ratios are important when considering a loan approval because they give lenders insight into how much of your income is available to make payments after all debts and obligations are taken care of each month.
How is a debt-to-income ratio calculated?
Your debt-to-income ratio is all your monthly debt payments divided by your gross monthly income. This number is one way lenders measure your ability to manage the payments you make every month and repay the money you borrow.
A low debt-to-income ratio proves you manage debt well. A higher ratio indicates higher risk — that you may have trouble making loan payments. That’s why a high debt-to-income ratio can prevent you from qualifying for certain types of loans, such as a mortgage or auto loan.
To calculate your debt-to-income ratio, add up all your monthly debts — rent or mortgage payments, car loans, personal loans, student loans, credit card payments, child support, alimony — then divide this number by your gross monthly income. Gross income is all the money you earn in a month before taxes and other deductions are taken out.
What is a good debt-to-income ratio?
A debt-to-income ratio is the percentage of your monthly income that goes toward paying debts. It’s used by lenders to determine whether you qualify for a loan and how much you can afford to borrow. A low DTI ratio speaks to a good financial health, while a higher one signals more financial strain.
The ideal debt-to-income ratio is 36%, but that varies depending on your income, expenses, and credit history. Having a low DTI ratio shows that you have a good handle on your finances and should be able to afford new loan payments. A high DTI indicates that you may have difficulty making your monthly payments, which could lead to defaulting on your loan or missing other important financial obligations.
Lenders typically like to see a DTI below 43%. If your DTI is higher than 50%, it will be difficult to get approved for a loan. When calculating your DTI, keep in mind that it’s important to consider all of your debts, not just those related to housing costs. This includes credit cards, car loans, student loans, medical bills, and any other form of borrowing.
See related pages on cosigner here, or this page about guarantor.
How can I improve my debt-to-income ratio?
Debt-to-income ratio is the percentage of your monthly income that goes toward paying your debts. It’s important to know because it affects whether you qualify for a loan. The higher your debt-to-income ratio, the harder it is to get approved for a loan or new line of credit. The lower your debt-to-income ratio, the better your chances of getting approved.
There are a few things you can do to improve your chances of getting approved for a loan, even if you have a high debt-to-income ratio:
- Get rid of high-interest debt: Paying off debt with a high interest rate will free up more of your income each month, which can lower your debt-to-income ratio.
- Boost your income: If you can find ways to bring in more money each month, you can lower your debt-to-income ratio by increasing your monthly income.
- Create a budget: Having a budget can help you see where your money is going and where you can cut back in order to free up more money to put toward paying off debt.
- Prioritize your debts: Make a list of all of your debts, from the ones with the highest interest rates to the ones with the lowest. Focus on paying off the debts with the highest interest rates first, as these will be costing you more money in the long run.
What are the consequences of a high debt-to-income ratio?
Debt-to-income ratio (DTI) is the percentage of your monthly income that is spent on repaying debts. A high DTI ratio could limit your ability to get approved for a loan or credit card and may mean that you struggle to make your monthly repayments. It can also have a negative impact on your credit score.