Debt-to-income Ratio, also known as DTI, is a financial calculation used to determine how well you're managing debt. It compares how much you owe to how much you earn.
Like your credit score, it's something both good to know, and important for your ability to borrow and spend money. It's an important measure of financial health, and how moneylenders know if how big a risk you are to repay loans. It's a snapshot of creditworthiness and how well you balance your budget.
What is a debt-to-income ratio?
For renters, the most important thing to know about DTI is it's a key factor in determining home loan approval. DTIs are most often used by mortgage companies, compared to other types of lenders. If you ever plan on moving out of your apartment into a house, having a good DTI score will help secure a home loan.
But mortgages aren't the only financial transaction in which DTIs are implemented. For renters, having a good DTI ratio is also key in acquiring automobile, student, personal or other loans. But while DTI is nearly always used for mortgages, it's less common for other loans which can often be approved with just a high credit score and proof of income. However, with a lower credit score, renters with good DTI ratios have a better chance at approval.
Conversely, if you are looking for a new apartment, a good DTI ratio might be a factor in lease approval. Not all landlords will ask for DTI score, but many use the result — in conjunction with the rent-to-income ratio, credit score, etc. — to assure you are living within your means and can pay rent.
Below are some more detailed considerations for understanding debt-to-income ratio.
How to calculate debt-to-income ratio
The debt-to-income ratio calculation is simply monthly debt payments divided by gross monthly income. But what exactly is involved in those two variables?
The divisor is simple. Your gross monthly income is the total amount of money earned from employment, interest payments, investments and the like, before taxes and other deductions are taken out.
The dividend is a little more complex. The figure is, at its base, how much money you hand over each month for recurring payments or repayments. The complication is deciding what payments are part of the calculation and which are not.
These are examples of monthly payments that count toward DTI ratio:
- Rent *
- Mortgage
- Auto loans
- Student loans
- Personal loans
- Child support
- Alimony
- HOA fees
These are examples of monthly payments that do not count toward DTI ratio:
- Health insurance
- Utilities
- Groceries
- Gas and transportation costs
- Clothing
- Taxes
* Monthly rent payment is usually not included in DTI when applying for a home loan since it is assumed current rent will be replaced by future mortgage.
What is a good debt-to-income ratio?
Your debt-to-income ratio helps determine how comfortable you are with your debt, and if you're in a good place to apply for loans and credit. So it's not just important to know what is a debt-to-income ratio, but what is a good one.
- Any DTI below 35 percent is considered good. It shows you have manageable debt and disposable income after paying bills.
- DTIs between 36 percent and 49 percent are viewed as adequate. Your ratio isn't bad but could be better. This means moneylenders might look harder at other factors.
- With a DTI over 50 percent, you're going to have trouble securing loans. It means you have limited funds to spend and could default, particularly if an unforeseen financial event occurs.
A low DTI ratio shows a good balance between debt and income. Having a lot of debt doesn't mean a high DTI. It depends on your earnings and how much of it goes into paying debt.
Specifically for home loans, mortgage companies prefer a DTI lower than 36 percent, with no more than 28 percent of that dedicated to rent or existing mortgage. DTI ratios over 43 percent are usually a no-go entirely.
Other debt-to-income ratio factors
A common question is if your debt-to-income ratio can affect your credit score. No, it does not. Credit reporting companies do not collect income data, so, therefore, cannot report DTI on your credit report.
One caveat to be aware of is that the DTI ratio doesn't distinguish between different interest rates or the cost of servicing debt. Your credit card and auto loan could have wildly different interest rates, but DTI considers them the same level of debt. It also doesn't take savings into account.
Can I improve my debt-to-income ratio?
If you have a high debt-to-income ratio, can you lower it? Yes, you certainly can. These are some actions you can take to lower that score:
- Pay off your smallest debts
- Raise the monthly amount you pay into paying off loans
- Increase income or start a second job
- Take out a debt consolidation loan
- Open a balance transfer credit card
- Ask creditors to reduce your interest rate
- Add a co-signer to your loans
Additional resources
- Snowball vs. Avalanche: Which is Better to Pay Your Debt?
- How to Pay Off Debt Right Now Even if You're Feeling Unsure
- How to Create a Budget Worksheet
- What is an Income Requirement When Renting? Rental Definition and Examples
- Why You Should Never Use a Loan to Pay Rent
The information contained in this article is for educational purposes only and does not, and is not intended to, constitute legal or financial advice. Readers are encouraged to seek professional legal or financial advice as they may deem it necessary.
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