Your debt-to-income ratio (DTI) compares the total amount you owe every month to the total amount you earn. Lenders may consider your debt-to-income ratio in tandem with credit reports and credit scores when weighing credit applications.
To calculate your DTI, divide your total recurring monthly debt (such as credit card payments, mortgage, and auto loan) by your gross monthly income (the total amount you make each month before taxes, withholdings, and expenses). For example, if your total monthly debt is $3,000, and your gross monthly income is $6,000, you would divide 3,000 by 6,000 to get .5 or 50%.
Your income is not included in your credit report, so your DTI never affects your credit report or credit score. However, many lenders calculate your DTI when deciding to offer you credit. That's because DTI is considered an indicator of whether you'll be able to repay a loan. If you have a low DTI, meaning you make much more than you owe, you might be better able to repay a new loan. However, if you already have a lot of debt, taking out additional credit might make it difficult for you to meet your financial obligations.
What's a Good Debt-to-Income Ratio?
Generally, to get a qualified mortgage, your DTI needs to be below 43%. In fact, the lower your DTI the better, and many lenders prefer ratios below 36%.
There are also two types of DTIs — front-end and back-end:
- Front-end DTIs examine only how much of your gross income goes toward housing costs, including mortgage payments, property taxes and homeowner's insurance.
- Back-end DTIs compare gross income to all monthly debt payments, including housing, credit cards, automobile loans, student loans and any other type of debt.
If you're applying for a mortgage, many lenders will prefer a front-end DTI of less than 28%. To qualify for an FHA loan, you'll need a front-end ratio of less than 31%.
How to Improve Your Debt-to-Income Ratio
When you're applying for a mortgage, improving your debt-to-income ratio can make a difference in how lenders view you. Several steps can help you achieve a lower DTI, including:
- Reduce your total debt by paying off credit cards and paying down any other loans that you can.
- Avoid taking on new debt.
- Consider a debt consolidation loan to make it easier to reduce debt faster.
- Improve your income by asking for a raise, getting a second job or finding a new primary job that pays more.
- Review your budget to see where you could save money to put toward paying down debt. If you don't have a budget, start one.
How Debt Affects Your Credit Scores
Since income does not appear on your credit report and is not a factor in credit scoring, your DTI ratio doesn't directly affect your credit report or credit scores. However, while your income is not reported to credit bureaus, the amount of debt you have is directly related to multiple factors that do affect your credit scores, including your credit utilization ratio. This ratio compares your total revolving debt (such as credit cards) with the total amount of credit you have available. Credit utilization ratios are important factors in determining many credit scores.
Other ways your debt can affect your credit scores include:
- The total amount of debt you have
- The age of loans or revolving debts
- The mix of types of credit you're using
- How many recent hard inquiries have been made into your credit report
- How consistently you've paid your debts over time
How Your DTI is Used by Lenders
When you apply for a mortgage, lenders will look at DTI, your credit history and your current credit scores. Why? Because all this information taken together can help them better understand how likely you will be to repay any money they loan to you. While there's no immediate way to improve a credit score, certain actions can help (and in the long run, can show your overall understanding and application of successful credit behaviors), and can start you on a better path today. Think about:
- Pay down existing debt, especially revolving debt like credit cards. This will help improve both your DTI and your credit utilization ratio.
- Pay all bills on time every month. Late or missed payments appear as negative information on credit reports.
- Avoid applying for any new credit, as too many hard inquiries in a short time frame could affect your credit scores.
- Use your existing credit wisely. For example, make a small purchase with a credit card and pay off the full balance right away to help establish a positive payment history.