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Your debt-to-income ratio (DTI) is an important part of your financial picture, and lenders typically consider it when reviewing loan applications.
Your DTI is calculated by dividing the total of your monthly debt payments by your gross monthly income. The resulting percentage indicates to lenders whether you are likely to be able to pay off the additional loan you are applying for.
As a general rule, many lenders require that borrowers have a DTI of 40 percent or lower. However, individual lenders set their own requirements and some lenders will accept applicants with higher DTIs.
Before applying for a personal loan, it is important to calculate your debt-to-income ratio so that you know where you stand and what you may qualify for.
Debt-to-income ratio statistics
While average household incomes have increased significantly over the years, average household debt has increased more rapidly. Especially now, as inflation is on the rise and people are paying more for necessities like food, rent and gasoline, many are falling deeper into debt.
- The average American has $90,460 in debt, including all types of consumer debt.
- The median household income in the U.S. was $79,900 in the first quarter of 2021.
- The average American household debt was $145,000.
- Personal loan lenders typically look for a debt-to-income ratio of 40% or less when reviewing applications.
What is debt-to-income ratio?
Your debt-to-income ratio is simply your total monthly debt divided by your total monthly income.
The lower your DTI ratio is, the better chance you have of qualifying for another loan. To calculate your DTI, add up all of your monthly debt payments and divide them by your gross monthly income. Your gross monthly income is the money you have earned in a month before taxes and other deductions are taken out.
For example, a borrower with a monthly mortgage payment of $900, a monthly car payment of $400, a minimum credit card payment of $100, and a gross monthly income of $4,000 would have a debt-to-income ratio of 35 percent.
Examples of debts that would be calculated into your DTI include mortgages or rental payments, car loans, credit cards, personal loans, home equity loans, student loans, child support/alimony payments, etc. Your DTI ratio does not include monthly utilities, car insurance expenses, cable bills, cell phone bills, health insurance costs or groceries/food.
The higher your debt-to-income ratio, the more debt you are in and the less likely you are to qualify for additional loans.
How do you calculate DTI ratio?
To calculate your debt-to-income ratio, start by adding up your monthly bills. You should include your rent or mortgage payment, car payment, credit card payments, child support/alimony payments and any loans you currently have.
Once you’ve done that, you will divide that total by your monthly income before taxes. This will leave you with a decimal number, which you can multiply by 100 to get your DTI ratio percentage.
Step 1: Add up the expenses
- Loans/credit card payments
- Child support/alimony payments
Step 2: Divide it by your monthly gross income
- Rental income
- Child support/alimony payments
Step 3: Convert it to a percentage
- Multiply the number by 100
- The percentage is your debt-to-income ratio
There are two components of your debt-to-income ratio that lenders assess when reviewing loan applications. These are your front-end DTI and back-end DTI. Your front-end DTI is your housing ratio. This includes housing expenses like mortgage payments, property taxes, homeowners association dues and homeowners insurance. Your back-end DTI is your front-end DTI plus all other monthly DTI debt. This ratio takes into account things like credit card bills, car loans and personal loans. Lenders tend to focus on your back-end DTI because it accounts for all of your monthly expenses.
If you need assistance calculating your debt-to-income ratio or want to double-check your calculation, try using a DTI calculator.
What is a good DTI Ratio?
While every lender has its own debt-to-income ratio requirements, it is harder to qualify for loans if you have a debt-to-income ratio of 43 percent or higher. A good debt-to-income ratio is generally anything under 36 percent. Having a good debt-to-income ratio allows you to qualify for mortgages, home loans, car loans and personal loans more easily. It is also likely to qualify you for better interest rates.
Why is DTI important?
Your debt-to-income ratio is one of the most important factors that lenders look at when assessing your creditworthiness. Your debt-to-income ratio, credit score and credit history provide a picture of your financial health that lenders use when deciding to accept or reject your loan applications. From a lender’s perspective, the higher your debt-to-income ratio is, the more risk they would be taking on. Essentially, having a low debt-to-income ratio, particularly if you also have a high credit score, proves to lenders that you are likely to pay your debts.
While almost all types of lenders consider your debt-to-income ratio when assessing a borrower’s creditworthiness, different types of lenders have different requirements. Here are some of the types of loans that consider your debt-to-income ratio:
- Car loans: Auto lenders typically require a debt-to-income ratio of 45 to 50 percent, or lower.
- Personal loans: Personal loan lenders typically require a debt-to-income ratio of 40 percent or lower.
- Home equity loans: Home equity loans and home equity lines of credit typically require a debt-to-income ratio of 47 percent or lower.
- Mortgages: Mortgage lenders typically require a debt-to-income ratio of 43 percent or lower.
Here is a breakdown of how different DTI ratios affect your ability to take out a new loan:
|DTI Ratio Range||What it means|
|DTI < 36%||Your debt is manageable, and you should have no problem getting a loan|
|DTI 36% – 42%||Some concerns from lenders. You might want to consider paying down some debt|
|DTI 43%- 50%||You May get declined and may have trouble paying off the debt you have|
|DTI > 50%||Paying down debt will be the hardest and borrowing options are limited|
What do I do if my DTI Ratio is bad?
If your debt-to-income ratio is not where you would like it to be, you aren’t alone. Data from the Federal Reserve indicates that total household debt in the U.S. increased by $266 billion in the first quarter of 2022. In spite of this, the rate of debt transitioning into delinquency has remained historically low. This means that, while people are taking on more debt, they are generally making their payments to creditors. Nevertheless, this increase in overall debt indicates that many Americans are likely struggling with a high debt-to-income ratio.
There are several things you can do to improve your debt-to-income ratio. Here are some strategies that could help you improve your DTI ratio:
- Pay down existing debt: If you are financially able to do so, increasing your monthly payments will decrease your overall debt faster and improve your DTI. For example, if you are only making the minimum payments on a credit card or personal loan, consider paying slightly more per month to work down your debt more quickly.
- Postpone large purchases: If your debt-to-income ratio is higher than you’d like it to be, you may want to consider holding off on using your available credit to make big purchases or applying for additional loans.
- Create and stick to a budget: Having a personal monthly budget is a great way to decrease your overall spending so that you are able to increase monthly debt payments and get out of debt faster. To start, it is a good idea to track your spending habits and make a list of necessary expenses.
- Check your DTI ratio regularly: Your DTI ratio changes as you pay off and/or take on debt. Try recalculating your DTI each month in order to track your progress.
If you are struggling to manage your debt, it may be a good idea to consider options like credit counseling, debt consolidation and debt relief. While there are lenders out there who cater to borrowers with bad credit and high debt-to-income ratios, it is worth considering whether or not taking on a new loan is manageable if you are already in debt. Unless you are in need of emergency funding, you should work on paying off your current debt before taking on more.
There is the option to consolidate your debt with a debt consolidation loan. While unsecured debt consolidation loans do tend to have tighter DTI requirements than other loans, it is a great option if you can apply with a co-signer. You could also consider a credit card balance transfer to consolidate your debt. Many credit card lenders offer low- to zero-interest introductory periods for borrowers who transfer their card balance. Consolidating all of your debt into one monthly payment and decreasing your interest rate is likely to lower your DTI.
The bottom line
Your debt-to-income ratio, along with your credit score, is a lender’s primary method of assessing your creditworthiness and your ability to pay off a loan. It is extremely important to prove reliability to lenders when applying for unsecured loans. Not only does your DTI impact your ability to qualify for a loan, but it also impacts the interest rate you will be eligible for. If you are looking to take out a home improvement loan, for example, it is important to know what your DTI ratio is in order to determine what you will qualify for and whether or not you can afford the new loan.
If your debt-to-income ratio is preventing you from making financial moves, consider working on lowering it to improve your overall financial health.