Your debt-to-income (DTI) ratio is the percentage of your gross monthly income (before taxes) that goes toward debt payments. Your DTI – along with other factors, like your credit history and credit score – can help lenders determine your level of risk and assess your ability to repay a new loan or line of credit.
How is debt-to-income ratio calculated?
You can calculate your DTI by dividing the sum of your monthly debt payments by your gross monthly income (before taxes).
Start by figuring out your gross (pre-tax) monthly income. Next, calculate the sum of your monthly debt payments, such as student loans, credit cards , mortgage payments and car loans. Finally, divide your total debt payments by your gross monthly income.
For example, let’s say your gross monthly income is $5,000. Each month, you pay $200 toward student loans, $500 toward your car loan, and $1,500 toward your mortgage. Your monthly debt payments total $2,200. 2,200 divided by 5,000 = .44, or 44%.
Why is debt-to-income ratio important?
Your DTI can give lenders insight into your overall finances and your ability to manage new debt. Along with other information, like your credit history and credit score, your DTI can help lenders assess what level of risk they’re taking on by approving you for a loan or line of credit. It can also help them determine what interest rate and other terms to offer.
A lower DTI can indicate a good balance between monthly debt payments and income. It may signal to lenders that you’ll be able to handle additional debt and reliably make monthly payments.
On the other hand, a higher DTI means that a larger proportion of your monthly income is going toward debt payments. It may suggest that you're already overwhelmed by (or close to overwhelmed by) existing debt. This may can make offering you credit a riskier prospect for a lender.
What debt-to-income ratio do lenders look for?
DTI requirements can vary from one lender to the next. The type of loan or credit you’re applying for may also make a difference.
In general, a lower DTI means you have a better chance of being approved for a loan or line of credit. If your DTI doesn’t meet the lender’s requirements, you may not be approved. A higher DTI can also mean a higher interest rate and less favorable terms.
Does your debt-to-income ratio impact your credit score?
Your DTI does not affect your credit score directly. However, these numbers are related.
Your debt-to-credit ratio (also called your credit utilization), which is the percentage of your total available credit you’re using, can impact your credit score. Carrying large credit card balances increases your credit utilization, which may lower your credit score. At the same time, a high balance may also drive up your minimum monthly payments and increase your DTI.
What if your debt-to-income ratio is too high?
If your DTI is too high, it can affect your ability to be approved for the loan or line of credit you want.
There are two ways to improve your DTI – lowering your monthly debt payments or increasing your gross income. Here are some methods of efficiently paying off debt and reducing your monthly payments:
Debt snowball method: With the debt snowball method, you focus on paying off one debt at a time, beginning with the smallest and eventually progressing to the largest. Paying off smaller debts first can mean some quick wins early on, which can be very motivating.
Start by listing your debts from smallest to largest. Continue making the minimum payments on everything while focusing any extra income on paying off the smallest debt. Once that’s paid off, switch your focus to the next-smallest debt, rolling in any funds you were using to pay off the smallest debt. Continue this strategy until you’ve paid everything off.
Debt avalanche method: The debt avalanche method focuses on paying off the highest-interest debt first, which can save you money on interest in the long run and help you pay off your debts faster.
Begin by listing all your debts from highest to lowest interest rate. Continue making minimum payments on all your debts while putting any extra money toward paying off the highest-interest debt faster. Once the highest-interest debt is paid off, roll that money into paying off the next-highest, then the next, until everything is paid off.
Disclosure: This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.
