What's a Good Debt to Income Ratio?

A person at the their desk calculating debt to income ratio on their calculator with pencil in hand to write it down on their notepad in front of them.

How to Calculate Debt to Income Ratio?

If you’ve recently been in the market for a mortgage loan, you may have come across the term “debt-to-income ratios.” This ratio is one of the many factors lenders use when considering you for personal loans or conventional loans.

Debt-to-income ratios (DTI) is the percentage of your monthly gross income (pre-tax) spent on repaying monthly debt obligations, including mortgage payments, rent payments, insurance premiums like homeowners insurance, outstanding credit card bills, and other personal loans.

There are two types of ratios that lenders evaluate, a front-end ratio and a back-end ratio. The front-end ratio is what percentage of your income would go towards housing expenses, and the back-end ratio includes the aforementioned along with other reoccurring total monthly debt payments. Living expenses, such as food and utilities are not included.

For this article, we will focus on the back-end ratio, which includes all monthly debt payments.

Understanding Debt-to-Income Ratios

Master Your DTI Ratio

To figure out your back-end debt to income (dti) ratio, you need to determine your gross monthly income before taxes. This must include all sources of income you may have.

Next, determine what your monthly payments are. If you’ve already created a budget or used a free debt management tool, this should be easy. Be sure to include credit cards, student loans, car loan, rent or mortgage payments, insurance premiums, child support, personal loans, conventional loans, and other other debt payments.

The final step to calculate your debt to income, is to divide your total monthly debt payments by your monthly gross income. To get a percentage, move the decimal point over to the right two times.

Here’s an example of a monthly debt-to-income formula calculation:

Monthly debt total:

  • Mortgage payment: + $1,100
  • Car loan Payment: + $300
  • Credit card monthly payment: + $200
  • Monthly debt payments total = $1,600

Monthly gross income:

  • Primary job: $3,000
  • Part-time job: $1,200
  • Monthly gross income = $4,200

Debt to income (DTI) calculation:

1. First, divide your total debt by your total income:

  • 1,600 / 4,200 = .3809

2. Then, multiply the number by 100 to find your percentage:

  • 0.3809 x 100 = 38.09

3. Calculated debt ratio = 38.09%

What is a Good Debt-to-Income Percentage?

Targeting an Optimal DTI Range

Generally, an acceptable DTI ratio should sit at or below 36%. Some lenders, like mortgage lenders, generally require a debt ratio of 36% or less. In the example above, the debt ratio of 38% is a bit too high. However, some loans allow for higher DTIs, please see below.

Why is Your Debt-to-Income Percentage Important?

DTI's Impact on Financial Health

A DTI is often used when you apply for a home loan. Even if you’re not currently looking to buy a house, knowing your DTI is still important.

First, your DTI is a reflection of your financial health. This percentage can give you an idea of where you are financially, and where you would like to go. It is a valuable tool for determining your most comfortable debt levels and whether you should apply for more credit.

Mortgage lenders are not the only lending companies to use this metric. If you’re interested in applying for a credit card or auto loan, lenders may use your DTI to determine if lending you money is worth the risk. If you have too much debt, you might not be approved. 

Women thinking on the couch about credit utilization ratio from credit report and the impact on her credit scores

How Much Does Debt Ratio Affect a Credit Score?

DTI Ratio and Credit Scores

Your income does not have an impact on your credit score. Therefore, your DTI does not affect your credit score.

However, 30% of your credit score is based on your credit utilization rate or the amount available on your current line of credit. Generally, your utilization rate should be 30% or lower to avoid having a negative effect on your credit score. That means that in order to have a good credit score, you must have a small amount of debt and actively pay it off. 

Strategies to Lower DTI Ratio

Lean How to Reduce Your DTI

The only way to bring your rate down is to pay down your debts or increase your income. Having an accurately calculated ratio will help you check your debts and give you a better understanding of how much debt you can afford to have.

Avoid employing short-term tricks to lower your ratio, such as getting a forbearance on your student loans or applying for too many store credit cards. These solutions are temporary and only delay repaying your current debts.

What is the Best Back-End Debt to Income (DTI) ratio?

Aiming for Ideal DTI Ratio for Lenders

Long-term, the answer is “as low as you can get it.”

  • However, hard numbers are better tools for comparison. Take a look at the following debt to income (DTI) ranges
  • 36% or less = Ideal
  • 37%-42% = Acceptable
  • 43% = Lenders typically have a maximum, with some exceptions up to 45%
  • 50% and up = DTIs of 50% or below with FHA, but exceptions can be made for an FHA or VA mortgage

If you’re trying to get a mortgage loan or auto loan, it’s a good idea to keep your back-end DTI ratio below 43%, though 35% or less is considered “ideal.”

Need Help to Lower Your DTI Ratio?

Leverage Expert Help to Improve Your DTI

Your debt to income (DTI) ratio is an important tool in determining your financial standing. If you’re struggling to come up with ways to lower your ratio or are looking for financial guidance, our expert coaches can help you. Contact us today to learn more about how our Debt Management Plans can help you take control of your monthly debt obligations.

Article written by
Melinda Opperman
Melinda Opperman is an exceptional educator who lives and breathes the creation and implementation of innovative ways to motivate and educate community members and students about financial literacy. Melinda joined credit.org in 2003 and has over two decades of experience in the industry.

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