A good debt-to-income ratio could allow you to borrow or refinance student loans for college, buy a car or even land a mortgage. But you might be wondering: What exactly is a good debt-to-income ratio?
A good debt-to-income ratio (DTI) is close to or below 35%, though you’ll likely be able to qualify for significant borrowing, such as for a home loan, with a DTI around 43%. A good DTI, in other words, could always be better.
During the loan approval process, your lender will calculate your DTI ratio. It uses this number to assess whether you have enough cash-flow to repay your new loan along with your other debts.
Still, you can calculate this figure on your own, determining whether you have a good debt-to-income ratio well before you even apply for credit. To get the full picture, let’s answer these three questions:
- What is a good debt-to-income ratio?
- How can you calculate whether you have a good debt-to-income ratio?
- How can you improve your debt-to-income ratio?
If you’re trying to qualify for student loan refinancing, secure a mortgage or obtain another form of credit, it’s wise to figure out your debt-to-income ratio before you start shopping, as different loan types have different requirements. To secure a qualified mortgage, for example, you’ll need a DTI of 43% or lower, according to the CFPB.
But, depending on the type of loan and your credit profile, the DTI requirement for mortgages can range from 31% to 50%, according to Experian.
Generally speaking, a DTI of less than 36% is what you should strive for. A DTI between 36% and 43% is OK, but it’s something you should try to lower before shopping for a mortgage. If your DTI is above 43%, you’ll likely struggle to secure significant funding, like a mortgage.
|What the experts say|
|“When applying for credit, potential lenders will look at this ratio to see if you are a prudent risk for them to take [on] or if you are overextended,” said Luis Rosa, a certified financial planner with Build a Better Financial Future. “The lower the debt-to-income ratio, the stronger you appear as a borrower in the eyes of the lender.”|
When it comes to other forms of loans, such as personal loans and auto loans, the DTI requirements can vary by lender. For example, Wells Fargo established three ranges of DTI ratios on its website:
- 35% or less: “Looking good”
- 36% to 49%: “Opportunity to improve”
- 50% or more: Time to “take action”
With that said, DTI requirements can be less stringent when applying for a personal loan or auto loan. If you’re interested in a specific form of credit with a specific group of lenders, ask about their underwriting criteria. The debt-to-income ratio for student loans, for example, could be more accessible to you than requirements for other types of debt.
Calculating your debt-to-income ratio is a fairly simple process:
- Add up all your monthly debt payments — such as private student loans, auto loans and personal loans.
- Then, divide that number by your gross monthly income, which is what you earn before deductions and taxes.
- Convert the decimal into a percentage.
Example of calculating DTI
Let’s say your current monthly debt payments look like this:
- Mortgage: $1,250
- Auto loan: $200
- Personal loan: $300
- Student loan: $350
That means your monthly debt payments would be $2,100. And let’s say your gross monthly income is $6,000 a month (meaning your salary is $72,000 a year).
To calculate your DTI ratio, you would divide your debt payments by your gross income per month. In this case, the calculation looks like this:
$2,100 / $6,000 = 0.35
Then you’d simply convert the output decimal to a percentage — in this case from 0.35 to 35%.
Or you can avoid all the math, by using this calculator to figure out if you have a good DTI.
Debt-to-Income (DTI) Calculator
Once you know this figure, you’ll know whether you have a good debt-to-income ratio, or one that needs improvement.
Fortunately, there are a handful of ways you can lower your debt-to-income ratio if it’s not as good as you’d like it to be.
“Lowering your debt-to-income ratio comes down to one of two things: Making more money, lowering your debt, or a combination of both,” Rosa said.
Below are a handful of ways you can improve your DTI:
- Take on a side gig or ask for a raise. Taking on a side gig for a period can be a great way to up your monthly income. “With the same amount of debt and increased income, your debt-to-income ratio will go down,” Rosa said. You can also ask for a raise at your current job.
- Take another look at your budget. If you don’t have a budget, create one. If you do have one, take another look at it to see if there are areas where you can cut back to create additional income. This extra income can be used to accelerate your debt payoff strategy, which will lower your DTI, Rosa said.
- Pay off your highest debt first. If you’re looking to lower your DTI quickly, Rosa advises paying off your debt with the highest minimum monthly payment first, as this is likely the account that’s affecting your DTI the most.
- Consolidate your debt. Consolidating or refinancing your debt might be a way to get a better rate and/or longer terms, which could lower your monthly payments, Rosa said. Just consider that if you take this route, you might be paying more in interest long term.
- Avoid taking on new debt. Unless you’re consolidating or refinancing existing debt, it’s probably wise to borrow anew. After all, increasing your debt load could send your DTI even further in the wrong direction.
Now that you know what a good debt-to-income ratio is, you can take steps to improve it before applying for new credit. Pushing your DTI in the right direction can help you ensure you’ll not only secure a loan, but you’ll get one with optimal terms.
Andrew Pentis contributed to this report.