If you’re shopping for a mortgage or a personal loan, you may have come across the term debt-to-income ratio — also called DTI.
Some important things to know about DTI:
- Lenders look at your DTI when determining whether or not to approve a loan
- The lower your DTI ratio, the better
- DTI requirements vary from lender to lender
What is your debt-to-income ratio?
Lenders use your DTI ratio when deciding if they should approve you for a loan and what interest rates to offer you. If your debt ratio is too high, they might decide to deny you for a loan.
While your DTI is primarily used by lenders to evaluate your application, it can also help you gauge your own financial health. Typically the lower your DTI, the better you’re doing financially. When evaluating your DTI, consider the following guidelines:
- 35% or less: If your DTI is 35% or less, your debt is at a manageable level. You have enough money to pay your bills, and you likely have some cash left over to splurge with or tuck away into savings. If you’re applying for a loan, most lenders will be happy to work with you (assuming you meet their other eligibility criteria).
- 36% to 49%: If your DTI is in this range, you’re likely able to manage your debt. However, money may be tight, with just a little left over after you pay your bills. If you’re thinking of applying for a loan, lenders may ask for more information to prove you can afford the added debt.
- 50% and up: If your DTI is 50% or more, debt is eating up a significant portion of your income, leaving you only a little to live on. With a DTI this high, it may be difficult — if not downright impossible — to find a lender willing to lend to you.
How to calculate your DTI
Calculating your DTI ratio is easy. Just add up your monthly payments — including monthly mortgage payment or rent, car loan, child support, credit card payments, etc. — and divide the total by your gross monthly income. The result will be a decimal, so multiply it by 100 to get your DTI.
(Total Monthly Debt Payments ÷ Monthly Income) x 100 = DTI
For example, let’s say you had a gross monthly income of $2,000 and the following monthly bills:
- $150 student loan payment
- $85 credit card payment
- $600 rent payment
Your monthly total debt would be $835. Divide that number by your monthly gross income — $2,000 — and you get 0.4175. Multiply that number by 100, and you have 41.75. That means you have a DTI of 41.75%.
($835 ÷ $2,000) x 100 = 41.75% DTI
That’s more middle of the road, so although not optimal, your debt is most likely manageable.
Why is DTI so important?
Your DTI ratio is an incredibly important part of your financial life. It can impact you in the following ways:
- Lenders look at your DTI alongside your credit score
- Lenders look at DTI when determining interest rates
- Your DTI can limit what loans and credit cards you can qualify for
1. Lenders look at your DTI alongside your credit score
When lenders receive your application for a loan or credit card, they look at a number of factors, including your DTI and credit score. A low DTI is a good indicator that you’ll repay the loan on time. When combined with a solid credit score, a low DTI shows lenders that you’re a reliable borrower.
2. Lenders look at DTI when determining interest rates
If you’re approved for a loan, lenders will review your DTI and credit score when determining your interest rate. The most sought-after borrowers are those with a low DTI, as you can likely be relied on to repay the loan. That means you’ll get lower interest rates than someone with a higher ratio.
3. Your DTI can limit what loans and credit cards you can qualify for
Your DTI plays an important role when you apply for new forms of credit, such as a mortgage loan or personal loan.
- Personal loans: The DTI requirements vary from lender to lender. Some lenders are willing to work with borrowers with high DTIs. However, you’ll likely have to pay a premium in the form of higher interest rates and fees.
- Home loans: The rules are more fixed. According to the Consumer Financial Protection Bureau, if you’re applying for a mortgage, your DTI should be 43% or less, otherwise, most mortgage lenders won’t lend to you. You may be able to find a creditor who offers mortgages to borrowers with higher DTIs, but you’ll likely have to make up for it in other ways.
For example, Fannie Mae recently increased its maximum DTI from 45% to 50%. However, to qualify for a mortgage with a 50% DTI, you need to have at least 12 months’ worth of cash reserves, and the loan amount must be equal to or less than 80% of the home’s value. That means you’d need to have a down payment of at least 20%.
Improving your DTI
Your DTI is an important number that is a marker of your financial health. If your DTI ratio is higher than you’d like it to be, you can improve it over time and raise your credit score by paying down debt, cutting your budget, and asking for a raise.
Looking to reduce your DTI? Pay off credit card debt even faster by taking out a debt consolidation loan.