Many people aren’t entirely sure what a debt-to-income (DTI) ratio is, let alone what theirs might be. In this article, we’ll break it down: what a DTI ratio is, how it affects your ability to get credit, what’s considered a healthy DTI ratio, how to calculate yours, and ways to improve it.
Understanding your DTI ratio
Your debt-to-income ratio measures how much of your monthly income goes toward debt payments. Lenders often use it to determine if you can afford additional debt and what interest rate to offer. Essentially, it’s a snapshot of your financial balance between income and obligations.
A DTI ratio is helpful not only when applying for credit but also for understanding your overall financial health.
What is a good DTI ratio?
There isn’t a single “perfect” DTI ratio. Lenders use it as an indicator of your ability to manage debt responsibly. Different institutions have different thresholds, so it’s important to know what the lender considers acceptable.
Here are three general benchmarks often cited by financial experts:
- 36% or less: This is considered a healthy ratio, showing that a manageable portion of your income goes to debt. It often indicates strong financial stability and may improve your chances of getting additional credit.
- Below 43%: If your DTI is under 43%, you are likely in good financial shape, particularly if you have a mortgage. Lenders usually prefer mortgage applicants to have a DTI below this level. You might still consider reducing debt to improve your position further.
- 43% or more: At this level, debt payments could be a financial burden. Lenders may be cautious about extending new credit. Fortunately, there are strategies to reduce your debt and lower your DTI.
DTI examples in real life
- Example 1: Monthly income = $4,500; monthly debts = $2,000 → DTI = 44%. Some lenders may deny new credit, or request proof of your ability to manage debt.
- Example 2: Monthly income = $2,000; monthly debts = $650 → DTI = 32.5%. This is a strong position and increases the likelihood of credit approval.
- Example 3: Monthly income = $3,500; monthly debts = $1,000 → DTI = 28%. This is an excellent ratio and can make you highly eligible for a mortgage or new credit.
Knowing your DTI ratio helps prevent surprises when applying for loans and provides a comprehensive view of your financial health.
Improving your DTI ratio
Your DTI ratio is just one aspect of your financial picture. Lenders also consider credit scores, payment history, and income. Even if your DTI isn’t perfect, you can still be financially healthy.
Here are ways to improve it:
- Pay down debt: Reducing what you owe is the fastest way to lower your DTI.
- Increase income: If possible, pursue a raise or take on a side job. Side hustles could include gig work, freelancing, or offering services like dog walking or tutoring. Extra income can go directly toward debt reduction.
By combining debt repayment with increased income, your DTI ratio can improve over time, putting you in a stronger financial position.
