Debt-to-Income (DTI) Ratio: What's Good and How To Calculate It (2024)

What Is the Debt-to-Income (DTI) Ratio?

The debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes to paying your monthly debt payments and is used by lenders to determine your borrowing risk.

Key Takeaways

  • The debt-to-income (DTI) ratio measures the percentage of a person's monthly income that goes to debt payments.
  • A DTI of 43% is typically the highest ratio a borrower can have and still get qualified for a mortgage, but lenders generally seek ratios of no more than 36%.
  • A low DTI ratio indicates sufficient income relative to debt servicing, and it makes a borrower more attractive.

Debt-to-Income (DTI) Ratio: What's Good and How To Calculate It (1)

Understanding the Debt-to-Income (DTI) Ratio

A low debt-to-income (DTI) ratio demonstrates a good balance between debt and income. In other words, if your DTI ratio is 15%, that means that 15% of your monthly gross income goes to debt payments each month. Conversely, a high DTI ratio can signal that an individual has too much debt for the amount of income earned each month.

Typically, borrowers with low debt-to-income ratios are likely to manage their monthly debt payments effectively. As a result, banks and financial credit providers want to see low DTI ratios before issuing loans to a potential borrower. The preference for low DTI ratios makes sense since lenders want to be sure a borrower isn't overextended meaning they have too many debt payments relative to their income.

As a general guideline, 43% is the highest DTI ratio a borrower can have and still get qualified for a mortgage. Ideally, lenders prefer a debt-to-income ratio lower than 36%, with no more than 28%-35% of that debt going towards servicing a mortgage payment.

The maximum DTI ratio varies from lender to lender. However, the lower the debt-to-income ratio, the better the chances that the borrower will be approved, or at least considered, for the credit application.

DTI Formula and Calculation

The debt-to-income (DTI) ratio is a personal finance measure that compares an individual’s monthly debt payment to their monthly gross income. Your gross income is your pay before taxes and other deductions are taken out. The debt-to-income ratio is the percentage of your gross monthly income that goes to paying your monthly debt payments.

The DTI ratio is one of the metrics that lenders, including mortgage lenders, use to measure an individual’s ability to manage monthly payments and repay debts.

Tip

Order your copy of Investopedia's What To Do With $10,000 magazine for more tips about managing debt and building credit.

Debt-to-Income Ratio Limitations

Although important, the DTI ratio is only one financial ratio or metric used in making a credit decision. A borrower's credit history and credit score will also weigh heavily in a decision to extend credit to a borrower. A credit score is a numeric value of your ability to pay back a debt. Several factors impact a score negatively or positively, and they include late payments, delinquencies, number of open credit accounts, balances on credit cards relative to their credit limits, or credit utilization.

The DTI ratio does not distinguish between different types of debt and the cost of servicing that debt. Credit cards carry higher interest rates than student loans, but they're lumped in together in the DTI ratio calculation. If you transferred your balances from your high-interest rate cards to a low-interest credit card, your monthly payments would decrease. As a result, your total monthly debt payments and your DTI ratio would decrease, but your total debt outstanding would remain unchanged.

The debt-to-income ratio is an important ratio to monitor when applying for credit, but it's only one metric used by lenders in making a credit decision.

Debt-to-Income Ratio Example

John is looking to get a loan and is trying to figure out his debt-to-income ratio. John's monthly bills and income are as follows:

  • mortgage: $1,000
  • car loan: $500
  • credit cards: $500
  • gross income: $6,000

John's total monthly debt payment is $2,000:

$2,000=$1,000+$500+$500\$2,000 = \$1,000 + \$500 + \$500$2,000=$1,000+$500+$500

John's DTI ratio is 0.33:

0.33=$2,000÷$6,0000.33 = \$2,000 \div \$6,0000.33=$2,000÷$6,000

In other words, John has a 33% debt-to-income ratio.

How to Lower a Debt-to-Income Ratio

You can lower your debt-to-income ratio by reducing your monthly recurring debt or increasing your gross monthly income.

Using the above example, if John has the same recurring monthly debt of $2,000 but his gross monthly income increases to $8,000, his DTI ratio calculation will change to $2,000 ÷ $8,000 for a debt-to-income ratio of 0.25 or 25%.

Similarly, if John’s income stays the same at $6,000, but he is able to pay off his car loan, his monthly recurring debt payments would fall to $1,500 since the car payment was $500 per month. John's DTI ratio would be calculated as $1,500 ÷ $6,000 = 0.25 or 25%.

If John is able to both reduce his monthly debt payments to $1,500 and increase his gross monthly income to $8,000, his DTI ratio would be calculated as $1,500 ÷ $8,000, which equals 0.1875 or 18.75%.

The DTI ratio can also be used to measure the percentage of income that goes toward housing costs, which for renters is the monthly rent amount. Lenders look to see if a potential borrower can manage their current debt load while paying their rent on time, given their gross income.

Real-World Example of the DTI Ratio

Wells Fargo Corporation (WFC) is one of the largest lenders in the U.S. The bank provides banking and lending products that include mortgages and credit cards to consumers. Below is an outline of their guidelines of the debt-to-income ratios that they consider creditworthy or need improvement.

  • 35% or less is generally viewed as favorable, and your debt is manageable. You likely have money remaining after paying monthly bills.
  • 36% to 49% means your DTI ratio is adequate, but you have room for improvement. Lenders might ask for other eligibility requirements.
  • 50% or higher DTI ratio means you have limited money to save or spend. As a result, you won't likely have money to handle an unforeseen event and will have limited borrowing options.

Why Is Debt-to-Income Ratio Important?

The debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes to paying your monthly debt payments and is used by lenders to determine your borrowing risk. A low debt-to-income (DTI) ratio demonstrates a good balance between debt and income. Conversely, a high DTI ratio can signal that an individual has too much debt for the amount of income earned each month. Typically, borrowers with low debt-to-income ratios are likely to manage their monthly debt payments effectively. As a result, banks and financial credit providers want to see low DTI ratios before issuing loans to a potential borrower.

What Is a Good Debt-to-Income Ratio?

As a general guideline, 43% is the highest DTI ratio a borrower can have and still get qualified for a mortgage. Ideally, lenders prefer a debt-to-income ratio lower than 36%, with no more than 28%-35% of that debt going towards servicing a mortgage. The maximum DTI ratio varies from lender to lender. However, the lower the debt-to-income ratio, the better the chances that the borrower will be approved, or at least considered, for the credit application.

What Are the Limitations of the Debt-to-Income Ratio?

The DTI ratio does not distinguish between different types of debt and the cost of servicing that debt. Credit cards carry higher interest rates than student loans, but they're lumped in together in the DTI ratio calculation. If you transferred your balances from your high-interest rate cards to a low-interest credit card, your monthly payments would decrease. As a result, your total monthly debt payments and your DTI ratio would decrease, but your total debt outstanding would remain unchanged.

How Does the Debt-to-Income Ratio Differ from the Debt-to-Limit Ratio?

Sometimes the debt-to-income ratio is lumped in together with the debt-to-limit ratio. However, the two metrics have distinct differences. The debt-to-limit ratio, which is also called the credit utilization ratio, is the percentage of a borrower’s total available credit that is currently being utilized. In other words, lenders want to determine if you're maxing out your credit cards. The DTI ratio calculates your monthly debt payments as compared to your income, whereby credit utilization measures your debt balances as compared to the amount of existing credit you've been approved for by credit card companies.

Debt-to-Income (DTI) Ratio: What's Good and How To Calculate It (2024)

FAQs

Debt-to-Income (DTI) Ratio: What's Good and How To Calculate It? ›

How do I calculate my debt-to-income ratio? To calculate your DTI, you add up all your monthly debt payments and divide them by your gross monthly income. Your gross monthly income is generally the amount of money you have earned before your taxes and other deductions are taken out.

How do you calculate good debt-to-income ratio? ›

How do I calculate my debt-to-income ratio? To calculate your DTI, you add up all your monthly debt payments and divide them by your gross monthly income. Your gross monthly income is generally the amount of money you have earned before your taxes and other deductions are taken out.

What is an acceptable DTI ratio? ›

35% or less is generally viewed as favorable, and your debt is manageable. You likely have money remaining after paying monthly bills. 36% to 49% means your DTI ratio is adequate, but you have room for improvement. Lenders might ask for other eligibility requirements.

Is a 7% debt-to-income ratio good? ›

DTI is one factor that can help lenders decide whether you can repay the money you have borrowed or take on more debt. A good debt-to-income ratio is below 43%, and many lenders prefer 36% or below. Learn more about how debt-to-income ratio is calculated and how you can improve yours.

What's a bad debt-to-income ratio? ›

Key takeaways

Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.

Is a 2% debt-to-income ratio good? ›

Your debt-to-income (DTI) ratio is how much money you earn versus what you spend. It's calculated by dividing your monthly debts by your gross monthly income. Generally, it's a good idea to keep your DTI ratio below 43%, though 35% or less is considered “good.”

What is the ideal mortgage to income ratio? ›

To determine how much you can afford using this rule, multiply your monthly gross income by 28%. For example, if you make $10,000 every month, multiply $10,000 by 0.28 to get $2,800. Using these figures, your monthly mortgage payment should be no more than $2,800.

Are utilities included in the debt-to-income ratio? ›

Monthly Payments Not Included in the Debt-to-Income Formula

Many of your monthly bills aren't included in your debt-to-income ratio because they're not debts. These typically include common household expenses such as: Utilities (garbage, electricity, cell phone/landline, gas, water) Cable and internet.

Is a 50% debt-to-income ratio good? ›

A general rule of thumb is to keep your overall debt-to-income ratio at or below 43%. This is seen as a wise target because it's the maximum debt-to-income ratio at which you're eligible for a Qualified Mortgage —a type of home loan designed to be stable and borrower-friendly.

Which on-time payment will actually improve your credit score? ›

Paying off your credit card balance every month is one of the factors that can help you improve your scores. Companies use several factors to calculate your credit scores. One factor they look at is how much credit you are using compared to how much you have available.

Does rent count in debt-to-income ratio? ›

These are examples of monthly payments that count toward DTI ratio: Rent * Mortgage. Auto loans.

How do I know if my debt-to-income ratio is too high? ›

Lenders look at DTI when deciding whether or not to extend credit to a potential borrower and at what rates. A good DTI is considered to be below 36%, and anything above 43% may preclude you from getting a loan.

What is considered a lot of credit card debt? ›

The general rule of thumb is that you shouldn't spend more than 10 percent of your take-home income on credit card debt.

What is a good credit score? ›

Although ranges vary depending on the credit scoring model, generally credit scores from 580 to 669 are considered fair; 670 to 739 are considered good; 740 to 799 are considered very good; and 800 and up are considered excellent.

Is 20% debt-to-income ratio good? ›

Generally, a DTI of 20% or less is considered low and at or below 43% is the rule of thumb for getting a qualified mortgage, according to the CFPB. Lenders for personal loans tend to be more lenient with DTI than mortgage lenders. In all cases, however, the lower your DTI, the better.

Do you include rent in debt-to-income ratio? ›

These are some examples of payments included in debt-to-income: Monthly mortgage payments (or rent) Monthly expense for real estate taxes. Monthly expense for home owner's insurance.

What is the 28 36 rule? ›

According to the 28/36 rule, you should spend no more than 28% of your gross monthly income on housing and no more than 36% on all debts. Housing costs can include: Your monthly mortgage payment. Homeowners Insurance. Private mortgage insurance.

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Horacio Brakus JD

Last Updated:

Views: 5861

Rating: 4 / 5 (71 voted)

Reviews: 94% of readers found this page helpful

Author information

Name: Horacio Brakus JD

Birthday: 1999-08-21

Address: Apt. 524 43384 Minnie Prairie, South Edda, MA 62804

Phone: +5931039998219

Job: Sales Strategist

Hobby: Sculling, Kitesurfing, Orienteering, Painting, Computer programming, Creative writing, Scuba diving

Introduction: My name is Horacio Brakus JD, I am a lively, splendid, jolly, vivacious, vast, cheerful, agreeable person who loves writing and wants to share my knowledge and understanding with you.