What Is a Good Income to Debt Ratio?
Your income and monthly debts create a key ratio for lenders. Learn how this metric reflects your financial health and impacts your ability to secure credit.
The debt-to-income (DTI) ratio is a financial metric that compares your total monthly debt payments to your gross monthly income. Lenders use this percentage to evaluate your capacity to manage new loan payments alongside your existing obligations. A lower DTI suggests a healthy balance between debt and income, while a higher ratio can indicate that a significant portion of your income is already committed to debt repayment.
Calculating Your Debt to Income Ratio
To determine your DTI, you must first identify your gross monthly income. This figure represents all your earnings before any taxes or deductions are taken out. Sources of income can include:
- Base salary or hourly wages
- Freelance earnings, commissions, and bonuses
- Alimony or child support
- Social Security benefits
Next, you must sum all of your recurring monthly debt payments. These obligations include:
- Rent or mortgage payment
- Minimum payments on all credit cards
- Auto, student, personal, or installment loan payments
- Court-ordered payments like alimony or child support
Variable monthly expenses such as utilities, groceries, and insurance premiums are not included in this calculation.
The formula is your total monthly debt payments divided by your gross monthly income. For instance, if your total monthly debts are $2,000 and your gross monthly income is $6,000, you would divide $2,000 by $6,000 to get 0.33. To express this as a percentage, you multiply the result by 100, which yields a DTI of 33%.
Understanding DTI Benchmarks
A ratio of 35% or less is viewed as ideal. This indicates that less than a third of your pre-tax income is allocated to debt, suggesting you have disposable income after meeting your obligations. Lenders see this as a low-risk profile, implying a strong capacity to handle additional payments.
A DTI ratio between 36% and 43% is considered manageable, but it signals a greater level of debt and moderate risk to lenders. Having a DTI in this tier means a larger portion of your income is consumed by debt. This leaves less of a cushion for unexpected expenses or savings, and you may still qualify for loans.
When a DTI ratio exceeds 43%, and particularly when it surpasses 50%, it is categorized as high-risk. Lenders may be hesitant to extend further credit, as it appears you could be overleveraged. A ratio in this range suggests that nearly half or more of your gross income is needed to service existing debt, which can limit your financial flexibility and increase the likelihood of default.
DTI Requirements for Major Loans
For conventional mortgages, which are loans not insured by a government agency, lenders prefer a DTI of 43% or less. Some lenders may allow a DTI as high as 50% for borrowers with strong compensating factors like a high credit score or substantial cash reserves. Lenders also consider a “front-end” ratio for housing expenses and a “back-end” ratio for all debts. A common guideline is the “28/36 rule,” suggesting housing costs shouldn’t exceed 28% of gross income and total debt shouldn’t exceed 36%.
Government-backed loans offer more flexible DTI requirements. Federal Housing Administration (FHA) loans, popular with first-time homebuyers, permit a DTI ratio of up to 43%. In some circumstances, the FHA may approve borrowers with a DTI as high as 50%. These loans are more accessible but come with a mandatory mortgage insurance premium (MIP) for the life of the loan in most cases.
Loans guaranteed by the U.S. Department of Veterans Affairs (VA) also have distinct standards. While the VA does not set a strict DTI limit, most VA-approved lenders prefer a ratio of 41% or less. For other types of credit, such as auto loans and personal loans, lenders will also assess DTI, though their specific thresholds can vary widely based on the lender’s internal risk policies.
How to Improve Your DTI Ratio
Improving your DTI ratio involves lowering your total monthly debt or increasing your gross monthly income. The most direct approach is to reduce your debt obligations by strategically paying down loans, particularly those with the highest interest rates. Avoiding the accumulation of new debt while you are trying to lower your ratio is also an important step.
Another strategy is debt consolidation or refinancing. Consolidating multiple high-interest debts, such as credit card balances, into a single personal loan with a lower interest rate can reduce your total monthly outlay. Similarly, refinancing existing loans, like an auto loan or mortgage, to a lower interest rate or a longer repayment term can decrease the required monthly payment.
Increasing your gross monthly income is the other way to improve your DTI. This could involve negotiating a salary increase, seeking a higher-paying position, or developing additional income streams. Taking on freelance work, starting a side business, or participating in the gig economy can provide extra funds that directly increase the denominator in the DTI equation, making your ratio more favorable.