Your debt-to-income ratio is a measure of how much you owe tracks against how much you take in. This figure is frequently used by lenders to evaluate how creditworthy an applicant is, or how likely they are to be able to pay their debt back on time. It also helps lenders determine what interest rate to charge borrowers.
A low DTI ratio demonstrates that there is probably sufficient income to pay debts and take on more. Typically, a DTI should be no more than 36% to obtain favorable credit. Here, learn more about what DTI is and how to calculate yours.
Key Points
• A person’s DTI or debt-to-income ratio is calculated by dividing total monthly debt payments by gross monthly income and multiplying by 100.
• Many lenders’ DTI guidelines are that housing expenses should not exceed 28% of gross monthly income and total debt payments should not exceed 36%.
• A low debt-to-income (DTI) ratio, typically 36% or less, can indicate better creditworthiness and ability to repay debt.
• Lenders may accept DTI ratios up to 43% or 50% if borrowers have strong credit scores, savings, and down payments.
• Strategies to lower DTI include increasing income, decreasing debt through consolidation loan, and using the snowball or avalanche method.
First, a Debt-to-Income Ratio Refresher
In case you don’t know how to calculate the percentage or have forgotten, here’s how it works.
DTI = monthly debts / gross monthly income
Say your monthly debt payments are as follows:
• Auto loan: $400
• Student loans: $300
• Credit cards: $300
• Mortgage payment: $1,300
That’s $2,300 in monthly obligations. Now, say gross monthly income is $7,000.
$2,300 / $7,000 = 0.328
Multiply the result by 100 for a DTI ratio of nearly 33%, meaning 33% of this person’s gross monthly income goes toward debt repayment.
What Is Considered a Good DTI?
The federal Consumer Financial Protection Bureau advises homeowners to consider maintaining a DTI ratio of 36% or less and for renters to consider keeping a DTI ratio of 15% to 20% or less (rent is not included in this ratio).
In general, mortgage lenders like to see a DTI ratio of no more than 36%, though that is not necessarily the maximum.
For instance, DTI limits can change based on whether or not you are considering a qualified or nonqualified mortgage. A qualified mortgage is a home loan with more stable features and without risky features like interest-only payments. Qualified mortgages limit how high your DTI ratio can be.
A nonqualified mortgage loan is not inherently high-risk or subprime. It is simply a loan that doesn’t fit into the complex rules associated with a qualified mortgage.
Nonqualified mortgages can be helpful for borrowers in unusual circumstances, such as having been self-employed for less than two years. A lender may make an exception if you have a high DTI ratio as long as, for example, you have a lot of cash reserves.
In general, borrowers looking for a qualified mortgage can expect lenders to require a DTI of 43% or less.
Under certain criteria, a maximum allowable DTI ratio can be as high as 50%. Fannie Mae’s maximum DTI ratio is 36% for manually underwritten loans, but the affordable-lending promoter will allow a 45% DTI ratio if a borrower meets credit score and reserve requirements, and up to 50% for loans issued through automated underwriting.
In the market for a personal loan? Some lenders may allow a high DTI ratio because a common use of personal loans is credit card debt consolidation. But most lenders will want to be sure that you are gainfully employed and have sufficient income to repay the loan.
Front End vs Back End
Some mortgage lenders like to break a number into front-end and back-end DTI (28/36, for instance). The top number represents the front-end ratio, and the bottom number is the back-end ratio.
A front-end ratio, also known as the housing ratio, takes into account housing costs or potential housing costs.
A back-end ratio is more comprehensive. It includes all current recurring debt payments and housing expenses.
Lenders typically look for a front-end ratio of 28% tops, and a back-end ratio no higher than 36%, though they may accept higher ratios if an applicant’s credit score, savings, and down payment are robust.
How Can I Lower My Debt-to-Income Ratio?
So what do you do if the number you’ve calculated isn’t your ideal? There are two ways to lower your DTI ratio: Increase your income, or decrease your debt.
Working overtime, starting a side hustle, getting a new job, or asking for a raise are all good options to boost income.
Strangely enough, if you choose to tackle your debt by only increasing your payments each month, it can have a negative effect on your DTI ratio. Instead, it can be a good idea to consider ways to reduce your outstanding debt altogether.
The best-known debt reduction plans (or payoff plans) are likely the snowball and avalanche methods, but there’s also the fireball method, which combines both strategies.
If credit card debt is an issue, here’s a tip: Instead of canceling a credit card, it might be better to cut it up or hide it. In the world of credit, established credit in good standing is looked upon more favorably than new. Eliminating a long-standing line of credit can lower your score.
Another way to decrease your debt could be to get a debt consolidation loan or credit card consolidation loan. This is a kind of personal loan, hopefully at a lower interest rate than your credit card offers. If so, it can save you on interest and give you just one simple loan to pay every month.
These personal loans are typically offered with a fixed interest rate and a term of one to seven years.
Recommended: How to Apply for a Personal Loan
The Takeaway
Your debt-to-income ratio matters because it affects your ability to borrow money and the interest rate for doing so. In general, lenders look at a lower DTI ratio (say, 28% to 36% maximum in some situations) as favorable, but sometimes there’s wiggle room. If you are struggling with high-interest debt, such as credit card debt, paying it off can positively impact your DTI. There are methods such as the debt snowball method, the debt avalanche technique, or taking out a personal loan.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.
FAQ
How do you calculate DTI?
To calculate your debt-to-income ratio, or DTI, divide your total monthly debt payments by your gross monthly income, then multiply that figure by 100 to get the percentage.
What is a good DTI?
What is considered a good DTI can vary along with the type of credit you are trying to secure. In some cases, a figure between 28% and 36% is considered on target, but in others, a ratio of 50% could be acceptable. Talk to your potential lenders to learn more.
What is the 28-36 rule?
The 28/36 rule is a guideline used regarding mortgages to determine how much a borrower can afford to spend on housing and overall debt. The rule says that a borrower should spend no more than 28% of their gross monthly income on housing (mortgage, property taxes, insurance) and a maximum of 36% on all debts (including housing). This is one way lenders may evaluate a prospective borrower’s creditworthiness.
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