What Is a Debt-to-Income Ratio and Why It’s Important  

Key Takeaways 

• A debt-to-income ratio measures how much of your monthly income is devoted to repaying debt. 
• Calculate your DTI by dividing your total debts by your gross monthly income and multiply by 100 to find the percentage. 
• Lower DTIs are better when it comes to borrowing money through mortgages, HELOCs and home equity agreements. 
• Try to keep your DTI below 45%, and below 36% is even better. 

Your debt-to-income ratio (DTI) is a number that compares your monthly debts to your monthly income, expressed as a percentage. It gives you an idea of how much of your money is going toward paying off debt.  

Lenders need to know your DTI when deciding whether and how much to lend to you, because it lets them know how much room you have left in your budget for new loan payments. A low DTI is better when you’re trying to get approved for a loan, mortgage, home equity agreement or other type of credit.  

Learn how to figure out your DTI, why it’s important for your financial success, and steps you can take to improve it. 

What is a debt-to-income ratio (DTI)? 

How much are you spending each month on loan payments, and how much do you earn? Your debt-to-income ratio takes your monthly debt obligations and divides them by your gross monthly income, which is what you make before taxes and other deductions.  

Your DTI shows how much of your income is taken up by debt and how much is left over for other expenses. If your DTI is low, you typically have room in the budget to take on another loan. But if your DTI is high, it means you don’t have very much wiggle room, and adding another loan could make it difficult for you to meet your monthly obligations.  

How to calculate your debt-to-income ratio 

You can use a simple formula to calculate your DTI ratio: 

• DTI = Total monthly debt / gross monthly income x 100 

Here’s how it works. Let’s suppose you earn $5,000 each month before taxes and retirement savings are taken out. Also suppose that you have $400 in student loan payments each month, $600 in car loan payments, and $100 in personal loan payments, for a total of $1,100 in monthly debt. Here’s how you would calculate your debt to income ratio: 

• DTI = (1,100 / 5,000) x 100 
• DTI = 0.22 x 100 
• DTI = 22% 

Dividing your total monthly debt ($1,100) by your gross monthly income ($5,000) gives you 0.22. Multiply 0.22 by 100 to find the percentage: 22%. Your DTI would be 22%, which would be considered good by many lenders. 

What’s a good DTI? 

Different lenders have different rules on what they will and won’t accept for a borrower’s DTI. For many mortgages, for example, lenders will want to see a DTI under 36% to know that you can make a monthly mortgage payment without too much risk of not being able to pay your bills. However, some mortgage loans will allow a DTI of 45% or even 50%, especially if there are other factors that show you are a responsible borrower (such as a good credit score). Fannie Mae, which requires mortgage loans to conform to certain criteria, will allow a DTI of up to 50%, but you’ll need either good credit, a hefty down payment (such as 25%), or up to six months of cash reserves in the bank to qualify. 

Why DTI is important 

Your debt-to-income ratio is one of the deciding factors in determining whether or not you’ll be approved for a loan. Other factors include your income, credit history, and down payment. 

If you’re considering taking out a mortgage or tapping your home equity, you’ll likely have better odds of approval and qualify for a lower interest rate if your DTI is low: 

• Mortgage: Ideally under 43% 
• Refinance: Ideally under 50% 
• Home equity loan: Ideally under 47% 
• Home equity line of credit: Ideally under 43%   
• Home equity agreement: Ideally under 45% 

Unlock, for example, requires a DTI of no more than 45% to qualify for a home equity agreement. 

However, your debt-to-income ratio is more than just a note on a lender’s underwriting criteria. Knowing your DTI can be a good barometer of your financial health. If your DTI is high, it can mean that you’re overextended. You may be living paycheck-to-paycheck and having a tough time making ends meet. It could be a sign that you need to tighten up your budget and lower your spending so you can make some headway on paying down your debts.  

Familiarize yourself with your debt-to-income ratio and recalculate it often as your payments change and loans are added or paid off. If your DTI is higher than you’d like, you can take steps to lower it. 

How to improve your DTI 

Before you apply for any sort of credit or loan, explore a few ways to improve your debt-to-income ratio. You have several options, whether you choose to increase the income side or decrease the debt side of the equation. 

• Boost your income: Increasing the money you have coming in each month will automatically improve your DTI. Consider asking for a raise or promotion, volunteering to pick up extra hours at work, or even transferring to a higher paying job. You could also pick up extra money on the side, perhaps by caring for kids or pets, selling extra gear, or otherwise offering your services. 
• Cut back where you can: If you have room in your budget to trim back, now’s the time to do so. Pause subscriptions, hit up the local library, and explore cheap meals to make at home. Even a few dollars here and there can add up to hundreds over the course of a month.  
• Pay down debt: With the money you’ve saved by careful budgeting, work on paying down your debts. Some people prefer to pay off the smallest debt and work their way up, while others prefer to tackle the debt with the highest interest rate first. Whichever method you choose, you’ll be decreasing your debt on your way to bigger and better things. 
• Consolidate your debts: Another option to free up monthly cash flow and improve your DTI is by consolidating your debts. This can often result in lower monthly payments. For example, if high-interest credit cards are eating away at your monthly budget, consider consolidating them into a lower-interest personal loan with a longer loan term. That can often lower your monthly payment, although it could take longer to pay off.  
• Tap your equity: Take advantage of the equity you’ve built in your home to pay off debt and improve your debt-to-income ratio. This method can create room in your budget through a home equity agreement, which gives you a lump sum of cash. Other ways of accessing your home equity include HELOCs, reverse mortgages and home equity loans. 

Keep track of your debt-to-income ratio as you make these changes. Improving your DTI will put you in a stronger position, whether you want to borrow money, qualify for a home equity agreement, or simply enjoy more budgetary breathing room. You’ll be glad you put in the hard work to improve your situation.