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Your debt-to-income ratio (DTI) is an indicator of your overall financial health. The fewer repayment obligations you have, the lower your DTI, and the lower your DTI, the less risky you’ll appear to a lender. If your credit score and your DTI both look good, you’ll qualify for more generous loans and better mortgage deals. But what is a good debt-to-income ratio, and how can you improve your DTI?
In short, if your DTI is 36% or below, you’re generally in the clear. We’ll delve into that number a little more later on. Meanwhile, let’s begin with a thorough explanation of how lenders calculate DTI.
Nearly all credit applications include a spot for your income. Credit applications also ask about existing repayment obligations. Lenders use both of these figures to calculate DTI—and you can, too. Here’s how:
Let’s see that in action:
You can calculate your own DTI using a pencil, paper and a calculator, or you can use our handy online DTI calculator.
Credit industry pundits occasionally mention “front-end DTI” and “back-end DTI.” Here’s what those phrases mean:
Most lenders focus on back-end DTI percentages because they paint a more realistic picture of applicants’ financial statuses.
Lenders use your DTI to gauge your ability to pay back a loan. The more monthly obligations you have, the higher your DTI will be. If you go over a certain threshold, lenders may be unwilling to approve applications for finance—even if you have great credit. Keep in mind, lenders all have their own DTI criteria, below are general, common guidelines. Let’s break that down in good, bad and ugly DTI:
Yes, a 19% debt-to-income ratio is very good—certainly far below the industry’s common maximum, which currently hovers between 43 and 49%. If your DTI is below 20, your payments are clearly manageable. You’re doing great—well done!
Don’t panic if you have a high DTI. Instead, try to lower your debt-to-income ratio before you apply for a personal loan or a mortgage. Here are three things you can do to improve your DTI:
If you think outside the box, you may be able to lower your DTI and improve your credit at the same time. Can you get a long-term family loan to consolidate some of your outstanding debts, for instance? Or could you sell something valuable and use the proceeds to eliminate one of your credit cards?
Mortgage lenders combine your DTI with a proprietary FICO score to determine your eligibility for a loan. Generally speaking, mortgage companies use a 28/36 DTI guideline. Here’s what that means:
To be clear, most mortgage companies won’t cut you off entirely with a prospective DTI higher than 36%, but they might start side-eyeing you if your potential DTI rises over 45%. If you have a really low DTI—say, 18%—and a good credit score, you probably won’t find it hard to get pre-approved.
Worried about medical debt and DTI? Thankfully, medical debts aren’t included in your DTI calculation—unless you don’t repay them on time and they go into collections. Once they’re in collections, they’ll factor into your DTI just like any other account on your credit report. To stop this from happening, try to work out an affordable repayment plan with your health care institution.
Your debt-to-income ratio doesn’t affect your credit score at all. The formula used to calculate your credit score doesn’t include your income. Instead, financial institutions look at your credit score in tandem with your DTI before making lending decisions.
Curious about how bureaus calculate your credit score? Let’s answer that question with a quick breakdown:
Auto loan providers use payment-to-income ratio (PTI), rather than DTI, to calculate an applicant’s creditworthiness. PTI is quite similar to DTI—in fact, your DTI includes your PTI. In a nutshell, PTI is the future percentage of your income taken up by your car payment and insurance. Most lenders prefer applicants with a PTI under 20%.
PTI is easy to calculate. Simply take your monthly income and multiply it by 0.20 to find your maximum PTI. Let’s use the same monthly income we used above—$2,900—as an example:
A similar calculation applies if your lender has a 15% PTI cap—in the example above, you’d be capped at $435. Interestingly, the same ratio applies whether your new car is your first, second or third vehicle.
To recap, you can calculate your DTI by dividing your total monthly debt-related outgoings by your total monthly pre-tax income. If your DTI is under 35%, you’re doing well—but there might be room for improvement. The higher your DTI, the less likely you are to get credit—many mortgage companies, for instance, don’t lend to applicants with a DTI over 45%.
Medical debt doesn’t affect DTI, and your DTI won’t affect your credit score. PTI is similar to DTI—it’s basically debt-to-income ratio for a car loan—and it’s used by auto loan providers to calculate the maximum amount for your monthly car repayment and insurance. Finally, you can lower your DTI by paying off debt, increasing your income or adding a cosigner to your loan application.
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