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What is your debt-to-income ratio?
Your debt-to-income ratio (DTI) is your total monthly debt payments divided by your gross monthly income. Lenders use it to assess how much of your income goes toward repaying debts (such as your mortgage and credit card bills) and housing costs.
If your DTI ratio is high, it means that a lot of your income goes toward your debts and you don’t have much left over for other purchases. Lenders see this as a sign of poor financial health.
Along with your credit history, your DTI ratio is one of the major factors that lenders consider when assessing your creditworthiness, or the likelihood that you’ll repay your debts. If your DTI is too high, it can make it hard to get new lines of credit or loans.
How to calculate your debt-to-income ratio
You have more than one type of debt-to-income ratio. The types are very similar, but you calculate them in slightly different ways.
The two types of debt-to-income ratio are:
- Back-end DTI: This factors in all of your debts, including non-housing expenses. This type of DTI is more inclusive than the next type, which is specific to housing.
- Front-end DTI: Also called your “housing ratio,” this is the proportion of your monthly income that goes toward housing expenses if you’re a homeowner.
The way lenders use each type of DTI ratio is described further down in this article.
How to calculate your back-end DTI ratio
To calculate your back-end debt-to-income ratio, follow these three steps:
1. Add up your monthly bills
Your monthly bills include payments toward installment loans (such as car loans, student loans, or mortgages) and revolving credit accounts (such as credit cards, retail cards, and personal lines of credit).
According to the United States Department of Housing and Urban Development, your DTI includes expenses that you must pay in the next 10 months. 1
For example, your back-end DTI includes the following expenses:
- Mortgage payments
- Student loan payments
- Auto loan payments
- Credit card payments
- Alimony and child support payments (or other court-ordered expenses)
- Monthly payments on a second home
- Long-term medical debts
- Past-due taxes
Most sources claim that lenders exclude your groceries, utilities, gas, phone bills, medical expenses that have not turned into debts, and taxes (except past-due taxes) from your DTI. 2 They also usually exclude childcare and insurance-related expenses, although at least one government program (the US Department of Housing and Urban Development’s Making Home Affordable program) includes them. 3
By way of example, let’s say your outstanding debts consist of a mortgage ($1,500 per month), a car loan ($500 per month), and a student loan ($500 per month). You can add these amounts together to find out what you spend on debt payments each month:
$1,500 + $500 + $500 = $2,500
2. Divide the total by your gross monthly income
Next, divide the total amount you pay on debts each month by your gross income (before taxes).
For example, here’s what you would do if you earn $5,000 per month before taxes and spend $2,500 of that on debts, as in the previous example:
$2,500 / $5,000 = 0.5
3. Obtain your DTI ratio as a percentage
Finally, multiply your result by 100 to get a percentage. This is the answer you’d get from the example above:
0.5 × 100 = 50
In this case, your back-end DTI is 50%. Note that DTI is always expressed as a percentage. A lower percentage is considered less risky by lenders.
To make life easier, you can use online debt-to-income ratio calculators like this one provided by the Consumer Finance Protection Bureau.
How to calculate your front-end DTI ratio
Calculating your front-end debt-to-income ratio is very similar—the only real difference is that you should only include housing expenses.
To calculate your front-end DTI, do the following:
- Add up all of your housing costs. Specifically, this refers to the principal, interest, taxes, and insurance (known as your “PITI”) that make up your mortgage payments.
- Divide the total by your gross monthly income. You should get a number between 0 and 1 (assuming your income is sufficient to cover your expenses, which it should be!)
- Multiply the result by 100 to get a percentage. This percentage represents how much of your income is spent on housing.
For example, let’s say your gross monthly income is $10,000 and your monthly mortgage payments include the following:
- Principal: $1,100
- Interest: $500
- Tax: $200
- Insurance: $200
Following the steps above, here’s how you’d calculate your front-end DTI ratio:
$1,100 + $500 + $200 + $200 = $2,000
$2,000 / $10,000 = 0.2
2 × 100 = 20
As you can see, your front-end DTI ratio is 20%.
What is a good debt-to-income ratio?
While your income doesn’t affect your credit score, your debt-to-income ratio does affect your ability to secure lines of credit.
What counts as a good debt-to-income ratio depends on your lender, what type of credit you’re applying for, and your financial history. As a rule of thumb, the Consumer Finance Protection Bureau recommends that your DTI ratio not exceed 36% if you’re a homeowner or 15%–20% if you’re renting. 4
A lower DTI ratio is virtually always better. It indicates that you’ll be able to easily manage your payments and that your budget allows for more financial obligations.
Does a good DTI ratio mean a better mortgage interest rate?
Yes, having a good DTI ratio can get you better mortgage interest rates. This is because your DTI ratio is one of the main factors that lenders consider when assessing your risk as a borrower.
Lenders charge higher interest rates to high-risk borrowers to compensate for potential losses. If your DTI ratio is too high, they may also impose additional requirements that you must meet before they give you a mortgage.
On the other hand, if you have a low DTI ratio, lenders can afford to give you better rates because you’re less likely to default on your loan.
How much should my debt-to-income ratio be for a mortgage?
DTI ratio requirements vary depending on the type of mortgage you’re getting. Here are the maximum DTI ratios that lenders are willing to accept for different types of mortgages:
- Qualified mortgage: 43% 5
- Conventional mortgage: 36%, but exceptions can be made to accept DTI ratios up to 45% (Freddie Mac) or 50% (Fannie Mae) 6 7
- FHA loan: 43%, but exceptions can be made to accept DTI ratios of up to 57% 8 9
- VA loan: 41%, but exceptions can be made for applicants with compensating factors 10
The percentages above represent back-end debt-to-income ratios. Mortgage lenders usually want to see a front-end DTI that doesn’t exceed 25%–28%. 11 That number is smaller because your front-end DTI ratio includes fewer debts, so it should usually be lower than your back-end DTI ratio.
How your debt-to-income ratio works when you apply for a car loan
Auto loan providers usually don’t have a DTI requirement. Instead, they use something called payment-to-income (PTI) ratio to determine your creditworthiness.
Your PTI is like a DTI ratio that’s specifically tailored for a car loan. It indicates the percentage of your income that you’d spend on your car loan payment plus insurance.
What payment-to-income ratio do you need to get a car loan?
There’s no universal minimum payment-to-income ratio required to get a car loan; it varies from lender to lender. However, to give you a rough idea of what lenders might be expecting, the borrowers in one study on long-term auto loans had an average PTI ratio of 12%. 12
Does my debt-to-income ratio impact my credit?
No, your debt-to-income ratio doesn’t affect your credit score. Your credit reports don’t contain income information, and credit scoring models don’t take your income into account at all in the calculation of your credit score. 13
However, if you have a high DTI ratio, you may also have a high credit utilization rate (the amount of your available revolving credit you’re using), which does have negative implications for your credit score.
How can I lower my debt-to-income ratio?
You can lower your DTI in two ways:
- By reducing the amount of debt you have
- By increasing your income
If you’re not in a position to take on another job, or if increasing your income just isn’t a feasible option, then you’ll need to focus on reducing your debt.
You can do this with good old-fashioned budgeting, but depending on how significant your debts are, you might find that’s not quite enough to get your DTI ratio as low as you’d like it to be.
If this is the case, then try these simple tips for lowering your monthly debt payments:
- Ask for lower interest rates: Try calling up your creditors and asking if they’ll reduce your interest rate. They’ll be more likely to agree to your request if your credit score is higher now than when you first opened the account or if you have a solid history of making consistent on-time payments.
- Explore your refinancing options: If you have an installment loan, like a car loan or mortgage, then you may be able to reduce your monthly payments by refinancing (replacing your current loan with a new loan). Refinancing might temporarily hurt your credit since it involves taking out a new loan, but it may also get you better loan terms.
- Consider debt consolidation: This is a particularly useful approach if you have a lot of high-interest debt (such as credit card debt). To consolidate them, use a debt consolidation loan to pay off your current debts. If your new loan has a lower interest rate, then you’ll end up paying less each month, which will lower your DTI ratio.
If you’re planning to apply for a mortgage in the near future, then refrain from opening new credit accounts or overusing your credit cards. That way, your prospective lender will see that you don’t have many existing obligations when they evaluate your DTI ratio.