What Is Debt-to-Income Ratio?

Your debt-to-income ratio (DTI), also called credit utilization rate, is one way to measure your financial health. It essentially shows how much of your monthly income you use to pay off debt.
 
Your debt-to-income ratio helps you — and prospective lenders — determine how much more debt you can reasonably take on.

How is debt-to-income ratio used?

Debt-to-income ratio is one factor that lenders use to determine creditworthiness. They also look at factors like your income and savings, monthly bills, assets, credit score, and payment history.
 
Your debt-to-income ratio might be relevant when you apply for a:

• mortgage or home loan
• car loan
• credit card
• personal loan

Your DTI may impact whether a lender will loan to you and, if they do, how much interest you’ll pay.

How to calculate debt-to-income ratio

To calculate your DTI, first add up your monthly debt obligations. Then divide that number by your gross monthly income (your monthly earnings before taxes and deductions are taken out).
 
Let’s say you make $6,000 a month before taxes, and you pay $1,500 toward debt each month — for your student loan, credit card debt, and car loan. Your monthly debt payments ($1,500) divided by your monthly income ($6,000) equal 0.25, so your DTI is 25%. That means you use 25 cents of every dollar you earn to make debt payments.

Income

Your gross income comprises:

• your base salary
• hourly wages
• bonuses
• commissions
• tips
• earnings from investments

Debt

When calculating DTI, your monthly debt includes recurring debt payments such as:

• mortgage principal
• mortgage interest
• mortgage insurance
• homeowners insurance
• property taxes
• homeowners association (HOA) dues
• timeshare and vacation property costs
• rental property costs
• credit card payments
• car loan
• student loan
• alimony
• child support
• IRS installment agreement payments
• monthly lease payments (such as for solar panels)

Nonrecurring expenses are not included in your DTI. Examples include:

• Internet and utility bills
• car insurance premiums
• cable TV and streaming service bills
• cell phone bills
• health insurance expenses
• grocery and dining costs
• entertainment expenses

What is a good debt-to-income ratio?

A low DTI ratio can improve your credit score and make you more attractive to lenders. If your DTI is too high, lenders may decide that you’re already carrying too much debt for your income.
 
Lenders differ on what a “good” debt-to-income ratio is. It often depends on the type of loan or credit you’re applying for.
 
Having a DTI of no more than 35% is ideal, although lenders often accept a higher DTI.
 
When applying for a mortgage loan, lenders generally prefer a DTI of 43% or less. In some cases, however, borrowers may qualify for a conventional mortgage loan or a Federal Housing Administration (FHA) loan with a DTI of up to 57%. You can often get a student loan, an auto loan, or a credit card if your DTI is in the high 40% range.

Paper Trail

When applying for a loan, be prepared to provide documents such as pay stubs, bank statements, tax statements, and a list of your monthly debts.

How to improve or lower your DTI

Is your DTI on the high side? If so, there are steps you can take to lower that number.

• Boost your earnings. If you’re overdue for a raise, consider talking to your boss. Or pick up some extra work on the side to supplement your income.
• Tighten your budget. This can free up cash so you can pay down debt more quickly. Check out Patelco’s budgeting tips.
• Avoid racking up more debt. Try to stop using your credit cards and postpone taking out new loans.
• Be strategic about paying down debt. There are various approaches you can take, such as:
  • the avalanche method Prioritize paying off debts with the highest interest rates first. This reduces the total amount of interest you pay, helping you shed debt faster.
  • the snowball method Focus on paying off your smallest debts first. This allows you to knock off some debts quickly, giving you early victories and a shot of motivation. Also, paying off a debt (even a small one) can help lower your DTI.
• Consolidate your debt. Combining various debts into a single loan can leave you with one lower monthly payment, often with a lower interest rate.
• Get expert help. A Patelco Certified Financial Specialist would be happy to provide advice and support.

As your DTI shrinks, you’ll see an improvement in your credit score, and it will be easier to get a loan or credit. The more aggressive you are about taking positive steps to reduce your DTI, the more quickly you’ll see results.
 
It’s best to lower your DTI before applying for a loan. But if you can’t wait, adding a co-signer to the loan can reduce your DTI in the eyes of a lender. Keep in mind that your co-signer will share equal responsibility for the loan, so if you miss a payment, it can hurt your co-signer’s credit too.