Your debt-to-income ratio is one of the key factors lenders look at when reviewing your loan or credit card application. Also known as your DTI, this number compares how much debt you have to your income.
It can seem intimidating, but your debt-to-income ratio doesn’t have to be something to fear. When you understand what it is, know the target ratios for different types of borrowing, and use strategies to improve your score, you can take control of your financial situation.
What Exactly is a Debt-to-Income Ratio?
Your debt-to-income ratio compares the minimum monthly payments on your debts to your gross monthly income. To calculate it, you divide your monthly debt payments by your gross monthly income.
For example:
- Monthly debt payments (mortgage, credit cards, student loans, auto, etc.): $2,000
- Gross monthly income: $5,000
- DTI = Debt Payments / Income
- $2,000 / $5,000 = 0.4 or 40%
In this example, the DTI is 40%. That means 40% of the person’s gross monthly income goes toward debt payments.
The two main types of DTI ratios lenders assess are:
Front-end DTI
The front-end DTI specifically looks at housing costs. It compares your total monthly housing payments to your total monthly income.
Housing costs include your:
- Mortgage principal and interest
- Real estate taxes
- Homeowners insurance
- HOA fees
- Other housing expenses like condo or co-op fees
Lenders want to see that your income is enough to comfortably cover these housing payments. A lower front-end DTI indicates you can better afford your home.
Back-end DTI
The back-end DTI looks at your total debt obligations including housing. It compares monthly payments on ALL debts like:
- Mortgage
- Credit cards
- Auto loans
- Student loans
- Alimony
- Child support
- Other debts with a monthly payment
The back-end DTI gives lenders a wider snapshot of your entire debt load and ability to manage all monthly payments.
Lenders look at both the front-end and back-end DTI when determining how much they will lend to you.
What’s Considered a Good DTI Range?
A good DTI depends greatly on the type of loan you need. While lower is generally better, guidelines vary by loan product.
Mortgages
For home loans, lenders usually look for a back-end DTI of 36% or less. However, they may approve DTIs up to 43% with good credit scores and additional down payment.
Front-end DTI recommendations for mortgages:
- Conventional loans: 28% or less
- FHA loans: 31% or less
- VA loans: 41% or less
Of course, your interest rate and eligibility for different loan programs will impact these DTI recommendations. Work with a mortgage officer to determine your specific target.
“If you can keep your debt-to-income ratio under 36 percent, you’ll look great to potential mortgage lenders.”
– Melissa Cohn, Regional Mortgage Sales Manager, Guaranteed Rate
Auto Loans
With auto lending, back-end DTIs up to 50% are often approved, although 36% is ideal. Lenders can be a bit more flexible with the back-end ratio since cars tend to hold value as assets.
However, the auto loan itself typically makes up a large portion of monthly debts. So keeping your auto payment comfortable based on income is key. Many auto lenders cap deals at payments of 10% to 15% of applicants’ gross income.
The average used car loan DTI is 30% to 35%.
Credit Cards
For unsecured debt like credit cards, under 30% is good while keeping utilization under 10% is ideal.
Since credit cards don’t collateralize other assets, lenders like to see consumers well under 40% DTIs before approving more available credit.
The chart below summarizes typical DTI recommendations by loan type:
| Loan Type | Back-End DTI Target |
|---|---|
| Mortgages | 36% or less |
| Auto Loans | 36% to 50% |
| Credit Cards | Under 30% |
So while guidelines vary, the standard advice across lending is “lower is better” when it comes to DTI.
3 Ways to Improve Your Debt-to-Income Ratio
If your DTI is higher than you’d like, there are options to improve it. With some strategic money moves, you can lower your ratios and improve your chances of loan approval.
Here are three impactful steps to take:
1. Pay Down Revolving Debt
One of the fastest ways to improve your DTI is paying down credit card balances. Since credit utilization counts toward your back-end ratio, eliminating those monthly payments can significantly improve your score.
Make a plan to aggressively pay down card debt – especially on high utilization cards. Tools like the debt avalanche or debt snowball methods make it more manageable.
- The debt avalanche method focuses on paying off the debt with the highest interest rate first. This saves more money overall compared to other methods.
- With the debt snowball method, you pay off debts in order from smallest to largest balance. This gives more quick “wins” to motivate you as you get debts completely paid off one by one.
Either option – avalanche or snowball – can work well to become debt free faster. The key is sticking to a strategic repayment plan and attacking that high cost revolving debt.
The less you owe on credit cards and lines of credit every month, the better your back-end DTI improves.
2. Increase Your Income
Another way to lower your DTI is to boost the “I” part of the equation – your income! Even a modest increase goes a long way when your total debt payments stay consistent.
Options to earn more include:
- Asking for a pay raise at your current job
- Finding a higher paying job
- Taking on a side hustle or part-time work
An extra few hundred dollars per month could make the difference in a strong DTI. Use income boosting tips that make the most sense for your situation.
Building multiple income streams helps create more stability too in case of job loss or shifts in one revenue source. With more coming in every month, your ratio metrics improve.
3. Reduce Housing Costs
Housing is often a major monthly expense. To reduce your front-end DTI specifically, look for ways to lower this spending. Consider options like:
- Refinancing your mortgage at a lower rate
- Downsizing to a more affordable home
- Getting a roommate to split housing costs
Even marginal reductions help improve your DTI. Meet with a HUD-approved housing counselor if you need help assessing housing affordability issues.
Nonprofit groups like the National Foundation for Credit Counseling (NFCC) also provide free financial advice and DTI counseling. Their certified experts help create budgets and debt payoff blueprints tailored to your situation.
Focus on the debt-reducing tactics that make the most sense for your finances. With strategic money moves, you can take control of your DTI and pave the way for future borrowing needs.
For more content, check out The Complete Guide to Personal Finance: In-Depth Answers to Your Credit and Debt Questions
Note: This blog post is written by a professional trader and investor based on personal experiences and opinions. It is not intended as financial advice. Always conduct your own research and consult a financial advisor before making any financial decisions.
