What’s a Good Debt-to-Income Ratio?

Regularly reviewing your finances could help you manage your expenses and work toward your goals. Part of that review might be checking your bank account for unauthorized charges, making sure your bills are all paid, and looking at your credit score periodically. 

Even so, you may not have a complete picture of your finances if you aren’t reviewing your debt-to-income (DTI) ratio along with these other factors.

So, what debt-to-income ratio should you aim for? Generally, when it comes to your DTI, the lower, the better. A high debt-to-income ratio could make it harder to get a loan. And it could also be a warning sign that your overall credit health—and your credit score—may be heading downhill.

A lower DTI likely shows that you can afford the amount of debt you have, and could have room in your budget for new financial priorities. 

Monitoring your DTI, especially if you’re navigating debt relief, could provide an early signal that you need to cut back on expenses or manage your debt differently. That’s why it’s important to keep track of your debt-to-income ratio, understand how to calculate it, and know how to reduce it.

What Is a Debt-to-Income Ratio?

Your debt-to-income ratio is the percentage of your total monthly income that goes toward paying your debts. Lenders use DTI to understand how much your current debt impacts your finances, helping them figure out how much additional debt you can afford.

If a lender thinks your debt-to-income ratio is too high, they may consider you a borrowing risk and not lend to you. On the other hand, you may get approved for a loan or mortgage more easily if you have a lower debt-to-income ratio. Your creditors may feel confident that you’ll pay back your loan, since your money isn’t already tied up in other debts.

Unless you’re making a major purchase that adds to your debt, your goal should typically be to keep your debt-to-income ratio as low as possible. This frees up more money in your budget for other spending, and could make it easier to save toward long-term goals. 

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What’s the Difference Between Debt-to-Income Ratio and Credit Score?

DTI and credit score are two factors that most lenders consider when you apply for credit. Either one could be a deal-breaker when you apply for a new credit account.

Your credit score helps lenders decide whether to lend to you. If it’s a “yes,” your credit score helps them decide what terms to offer. If you have a lower credit score, you may have a hard time getting a low interest rate on a loan.

Your credit score really matters when you’re looking to take out a new line of credit, like a loan or mortgage. Your payment history, credit utilization, and credit history are all important credit score factors. Your score helps creditors determine the likelihood that you’ll pay back the loan (referred to as your creditworthiness). 

Your DTI helps creditors decide how much to lend to you.

Debt-to-income ratio helps creditors know if you have room in your budget for a new payment. 

How Do You Calculate Debt-to-Income Ratio?

It’s simple to calculate your debt-to-income ratio on your own. Add up all of the monthly payments you make toward credit cards, personal loans, housing, and any other debts you have. Then, divide that total number by your gross monthly income (your income before taxes). Finally, multiply that number by 100 to get the percentage of debt to income.

In mathematical terms, this is how to calculate debt-to-income ratio:

([Total Debt Payments] / [Gross Income]) x 100 = [Debt-to-income ratio]

For example, if you earn $6,000 a month before taxes, and your rent and debt payments total $2,500, your debt-to-income ratio is 41.67%.

What Is a Good Debt-To-Income Ratio?

Every lender has slightly different criteria with regard to DTI. Here’s a general breakdown of what’s considered more versus less favorable.

• Below 36%: Most lenders will consider you for a new mortgage or loan, because you don’t have a large amount of debt relative to your income.

• Between 37% and 54%: Some creditors may consider you a credit risk, but might lend to you anyway.

• Above 55%: You may have trouble getting approved for a loan, but it’s not impossible. 

If you plan to apply for a mortgage or other large loan, it’s a good idea to try to reduce your DTI first. 

What Does Your Debt-To-Income Ratio Say About Your Financial Well-Being?

Your debt-to-income ratio speaks to your general financial well-being.

Having a higher debt-to-income ratio, for example, could mean that there isn’t money to save each month. You’re spending most of your income on your debt. Having a lower debt-to- income ratio, on the other hand, may indicate that you’ve taken on expenses you can comfortably afford.

That said, a low DTI isn’t automatically a sign of financial health.

The DTI calculation only accounts for your minimum monthly credit card payments on your various accounts. If you have large balances but low minimum payments, it’s possible to have a low DTI even if you’re deeply in debt. It’s also possible to have a favorable DTI but a less favorable credit score. Large credit card balances are notorious for dragging credit scores down. 

When Should I Be Concerned About My DTI?

You should be concerned about your DTI when your debts are difficult to keep up with, and when they’re preventing you from meeting other big goals. If you suffer a sudden financial hardship—like a job loss or illness—you may not have the funds you need to cover your debts.

Even one missed debt payment could negatively affect your credit score and trigger a higher APR, making it harder to pay your bills, and causing you to miss more payments. If you’re worried that your debt-to-income ratio is too high, there are solutions that could help you reduce it.

How Can You Reduce Your Debt-to-Income Ratio?

If you want to reduce your debt-to-income ratio, you need to reduce your debt and/or increase your income. And while you certainly can try to get a raise at work or find a better-paying job, you probably have more direct control over reducing your debt than increasing your salary. 

If you’re willing to work a second job, though, that could be an effective way to boost your income. There’s lots of opportunity for flexible work in the gig economy.

One of the least effective approaches for reducing DTI, at least as far as credit card debt goes, is making minimum payments on your balances. Making minimum payments means you're paying only a tiny portion of the principal owed. Over time, you could end up paying much more in interest. If you want to get rid of credit card debt, you need to pay more than the minimum each month.

A better choice could be a debt consolidation loan if it helps you move your debt from a higher interest rate to a lower interest rate. A lower rate could save you money in the long run. The problem, though, is that you may have trouble qualifying for a new loan if you already have a high debt-to-income ratio. 

If you’re having a hard time making minimum payments each month and can’t qualify for a debt consolidation loan, another option is a debt settlement program. This involves negotiating with creditors to forgive some of your debt. You can negotiate debts on your own, or work with a professional debt settlement company. Debt experts at a reputable company should have relationships with your creditors and knowledge of how the debt settlement process works, potentially leading to better outcomes.

Take Control of Your DTI and Your Financial Future

If you’re not happy with your debt-to-income ratio, it’s time to take action. Freedom Debt Relief can help you understand your options, including our debt settlement program. Our Certified Debt Consultants can work to help you find a solution that will help you decrease your DTI and put you on the path to a better financial future. Find out if you qualify right now.