What is a Good Debt to Income Ratio?

To get a loan, you need to prove you can pay for it.

That might seem a bit counterintuitive. “If I could pay for it, why would I be borrowing in the first place?” you ask.

Lenders aren’t in the business of giving away money to just anyone. They want proof you’re a responsible person who has the ability to pay back your debts.

One way to do that is by checking your debt-to-income ratio, or DTI.

That’s the ratio that compares your monthly debt payments to your monthly income. Essentially, if you’re already handing over most of your paycheck to cover other debts, your potential lender may think you won’t have enough left over to pay back the new loan.

If you’re in the market to buy a house or car, your DTI could play a big factor in deciding whether you’re approved, for how much and at what rate. 

Wondering what your DTI is and what’s a good score? We can help.

What Is Debt to Income Ratio?

A debt to income ratio (DTI) is a percentage you can calculate by dividing your total monthly debt payments by your gross income, or your total earnings before taxes. This number is important because it informs lenders on your ability to repay a loan. Your DTI is an important piece of the puzzle when it comes to your financial health. Even if you make a decent salary, if it’s eaten up by debts, lenders know you’re not in a great spot financially. 

Importance of Debt to Income Ratio

When you apply for a loan or take out a mortgage, the company responsible for the loan takes a close look at your debt to income ratio. If you have a good debt to income ratio, the lender thinks you’re financially responsible and likely to make your loan payments (on time, and in full). 

On the other hand, if your DTI is too high, lenders see this as a sign that you’re not responsible with your money, and therefore aren’t likely to pay back a loan.

Even if you’re not planning on taking out a loan or buying a house any time soon, you should still be aware of your debt to income ratio. Firstly, because you never know when you will need to take out a loan, and also because it’s a good signal of how you’re doing financially. If your DTI is high, you can use this as a motivator to start budgeting, saving and lowering that percentage for your future.

How to Calculate Debt to Income Ratio

Here’s the basic formula for a debt-to-income ratio:

DTI = Monthly debt obligations/Monthly pay x 100

Simple enough, right? But what goes into your monthly debt? And how about your monthly pay? 

If you’re calculating DTI simply for your personal budgeting purposes, you’re better off using your net monthly pay (the amount you get in your paycheck after taxes and withholdings) since that’s the money you actually have to pay off your debt. That DTI ratio is commonly known as consumer DTI.

But the overall DTI — the one lenders prefer — uses your gross monthly pay (your pre-tax pay). 

Why? Because it’s a more stable number that isn’t susceptible to month-to-month changes depending on your withholdings — plus it’s typically easier to get this information from a borrower quickly (divide your annual salary by 12).

OK, so the bottom number (aka divisor) is easy enough. The top half of the ratio (aka numerator) is a little trickier. 

For your overall DTI, you should only include monthly payments for debts — not ongoing expenses, according to Bruce McClary, vice president of communications for the National Foundation for Credit Counseling in Washington, D.C. Those debts could include credit cards, auto loans, student loans and installment payments for medical bills.

Your overall DTI ratio does not include monthly expenses such as groceries, gas and utilities.

“The golden rule is only to include things that show up on the credit report,” McClary said. 

However, that raises the question of whether you should include your rent, which is technically not a debt. 

If you’re calculating your DTI strictly for personal planning, you should include rent as part of your expenses. But will lenders include it? That depends, according to Brent Weiss, CFP and chief evangelist of Facet Wealth.

“If your lease is ending, or is month-to-month, you may have more flexibility with the lender,” he wrote in an email. “But the lender will still want to know what your monthly expenses will look like going forward.”

If you’re applying for a mortgage, the lender may also factor in something called your front-end DTI, which only compares your housing expenses to your income. That number will include your current mortgage or rent unless you can prove that your obligation to make payments will end at a specified date (if you’ve completed a contract for selling your house, for instance). 

For example:

Jane wants to buy a house and applies for a mortgage. Each month, she pays $1,200 in rent (her lease ends next month), $400 for her auto loan, $600 in student loans and $100 toward her credit cards. Her gross monthly income is $3,500; her net monthly pay (after taxes and withholdings) is $2,600Consumer DTI

To figure her consumer DTI ratio (for Jane’s personal financial planning purposes):

$400 auto loan + $600 student loans + $100 credit cards + $1,200 rent = $2,300/$2,600 net pay = .88 x 100 = 88%

Front-end DTI

To figure Jane’s current front-end DTI ratio (housing expense):

$1,200 rent/$3,500 gross income = .34 x 100 = 34%

Overall DTI

To figure her overall DTI ratio (the lender doesn’t include her rent because her lease ends next month):

$400 auto loan + $600 student loans + $100 credit cards = $1,100/$3,500 gross income = .31 x 100 = 31%

If Jane was midway through a 30-year mortgage instead of nearing the end of her lease, her overall DTI ratio would be:

$400 auto loan + $600 student loans + $100 credit cards + $1,200 mortgage = $2,300/$3,500 income = .66 x 100 = 66%

What is Considered a Good Debt to Income Ratio?

So you know how to calculate debt to income ratio and why it’s important. Now for the main question: What is a good debt to income ratio?

“The numbers that many consider ‘good’ are 25%, 35% and 43% for housing, a healthy level of debt, and maximum DTI for lenders, respectively,” Weiss wrote. “Keep in mind, these are all rules of thumb.”

McClary agreed that while an overall DTI of 43% is typically the upper limit for lenders, the lower you can get your number, the better.

“It’s the same rule that applies on the open highway: If you’re driving right at the speed limit, your foot might get heavy and you might go over,” he said. “So that may look a little bit riskier than somebody driving 10 miles below the speed limit — or 15. 

“But I can’t pin down a specific number below 43 and say, ‘That’s the sweet spot.’”  

And when calculating for your own purposes, Weiss noted that rather than using an arbitrary number to decide your debt ratio, you should consider reversing the process and deciding what your debts and income should be based on what your goals are. 

“Most families save what they have left at the end of the month when they should be spending what they have left after saving,” he wrote. “Having a financial plan and knowing how much you want and need to save to achieve your goals will then help guide how much you can comfortably spend month-to-month.” 

Tips to Improve Your Debt to Income Ratio

Although it isn’t the only factor, lowering your DTI ratio can help when you’re applying for a loan. If yours is higher than you’d like, we have some suggestions for improving it:

• Increase your income.
  Whether it’s asking for a raise at work or taking on a steady side hustle, boosting your steady gross income will lower your DTI ratio.
• Decrease expenses.
  Cut your monthly expenses by taking on a roommate or double down on paying off some credit cards using the debt snowball method.
• Use rates to your advantage.
  You can also use financial strategies to lower your DTI ratio. By taking advantage of a balance-transfer offer and consolidating loans, you could potentially lower your minimum monthly payment on your credit cards, which reduces your monthly debt obligations. You could also try to settle your debt through company like National Debt Relief. 

You should always keep an eye on your DTI ratio, as it helps you track how well you’re managing your debt. Its importance in terms of loan qualification should just be a bonus, according to McClary.

“That’s one less thing you have to worry about,” he said.

Tiffany Wendeln Connors is a former staff writer/editor at The Penny Hoarder.

FAQs about Debt to Income Ratio