What is a Debt-to-Income Ratio?
The debt-to-income (DTI) ratio is the percentage of your total debt payments compared to your income before taxes. This is usually calculated on a monthly or yearly basis. For example, if you earn $1,000 each month and pay $480 towards debt, your DTI would be 48%. If you had no debt, your ratio would be 0%. There are different types of DTI ratios, which are explained in more detail below.
Another related term is the credit utilization ratio (sometimes called debt-to-credit ratio), which is the percentage of how much debt you owe compared to your total credit limit. This ratio affects your credit score, and the higher the percentage, the lower your credit score is likely to be.
Why Debt-to-Income Ratio (DTI) Important?
DTI, or Debt-to-Income ratio, shows how much debt a person or family has compared to their income. Lenders use this number to decide how risky it is to lend money to someone. Credit card companies, loan providers, and car dealerships all use DTI to assess the risk when working with different customers. If someone has a high DTI, lenders might think they won’t be able to pay back what they owe.
Different lenders have different rules about what DTI is acceptable. For example, a credit card company might approve someone with a 45% DTI, but a personal loan provider might consider that too high and decide not to offer a loan. DTI is just one factor lenders look at when deciding whether to offer a loan, and if they do, what terms to set. Generally, the lower the DTI, the better.
There are two main types of DTI:
Front-End Debt Ratio
This is also known as the mortgage-to-income ratio when buying a home. It’s calculated by dividing the total monthly housing costs by your monthly gross income. The front-end ratio includes your rent or mortgage payment, plus other housing costs like insurance, property taxes, and HOA fees. In the U.S., most lenders set a maximum front-end ratio of 28%.
Back-End Debt Ratio
This ratio takes a broader view of your debts. It includes everything from the front-end ratio, plus other monthly debts like car loans, student loans, and credit cards. It’s also known as the debt-to-income (DTI) ratio and is more commonly used than the front-end ratio. In the U.S., the typical maximum back-end ratio is 36% for conventional home loans.
House Affordability
Lenders use DTI to help decide if someone can afford to buy a home. For conventional loans, the common limits are 28% for the front-end ratio and 36% for the back-end ratio. The Federal Housing Administration (FHA) allows higher limits, typically 31% for the front-end and 43% for the back-end. VA loans can go up to 41% for both ratios. You can use a House Affordability Calculator to check these ratios and figure out how much mortgage you can afford.
Financial Health
While lenders use DTI ratios to assess loan risk, you can also use them to check your own financial health. In the U.S., a DTI of 33% or less is considered manageable. A DTI over 50% usually indicates financial strain, meaning more than half of your income is going toward paying off debt.
How to Lower Debt-to-Income Ratio
Increase Income:
One way to reduce your DTI is by increasing your income. This can be done by working overtime, getting a second job, asking for a raise, or earning money from a hobby. If your income goes up while your debt stays the same, your DTI will go down.
Budget:
Creating and sticking to a budget helps you track your spending. It allows you to find areas where you can cut back, such as on vacations, dining out, or shopping. A budget can also help you track your DTI each month, so you can work towards lowering it. If you need help with budgeting, consider using a Budget Calculator.
Make Debt More Affordable:
To lower high-interest debt, such as credit cards, consider refinancing. Start by calling your credit card company and asking for a lower interest rate—if you have a good payment history, they might grant your request. Another option is consolidating multiple high-interest debts into one loan with a lower interest rate.
If you want to lease a car then you can use our Car Lease Calculator to calculate your monthly lease payments.