When applying for a new loan, especially a car loan or mortgage, lenders will consider several factors before approval. First, they check your credit report and verify you manage your debt well. Second, they will consider your debt to income (DTI) ratio.
Your DTI gives the lender a better look into your current financial health, as it shows just how much of your income goes toward debt. DTI is a vital part of the loan approval process — even with a near-perfect credit score, a bad DTI ratio could result in you getting turned down for a loan.
So, what is a good debt to income ratio, and how can you improve a bad DTI? Keep reading for the answers. But first, let’s look deeper into what is a DTI ratio.
Before determining good and bad DTI ratios, you first need to fully understand what DTI is and what goes into calculating it.
When most lenders look at your DTI, they look at your back-end DTI, which covers all debts. A secondary DTI measurement called the front-end ratio, or front-end DTI only looks at debts related to housing expenses, like a mortgage, taxes, homeowner’s insurance premiums, home equity loans, HOA fees and more.
We’ll focus solely on the back-end DTI here, as it’s what most lenders use to determine your ability to repay a debt.
Lenders determine your DTI by taking all your monthly debt obligations, including:
- Mortgage payments
- Minimum credit card payments
- Personal loans
- Student loan payments
- Lines of credit
- Auto loans
- HOA fees
- Property taxes
- Child support
The lender then divides your total monthly debt payments by your gross monthly income — your income before taxes. The lender then multiplies that result by 100 to get your DTI ratio, expressed as a percentage.
So, if you had $2,000 in monthly debt payments and $6,000 in monthly pre-tax income, you’d have a DTI ratio of 33.3% ($2,000 / $6,000 = 0.333 x 100 = 33.3%).
A good DTI ratio depends on the lender, as each will have slightly different requirements. That said, the personal finance industry has set some basic guidelines so you can see where you stand.
Here are the commonly accepted DTI tiers.
With a DTI of 36% or less, it means you still have 64% of your income to cover other bills and savings. Most lenders will view this as a good DTI, and you could qualify for most conventional loans.
Once you reach the 36% DTI threshold, lenders may start doubting your ability to handle another loan. This is especially true when shopping for a mortgage, which may drastically increase your DTI.
Most lenders may approve you with a 36% to 43% DTI, but you may not get their best loan options.
Once you reach a 43% DTI ratio, lenders will start to seriously doubt whether or not you can afford another loan. Most lenders will see you as too high risk to lend to, but there may be a few lenders with special programs that’ll approve you for a loan.
At 50% DTI, you likely can’t get approved for any new loans, even if you have good credit, as lenders will view you as an extremely risky borrower. At this point, you’ll need to look at your finances and find ways to reduce your high DTI before you start shopping for mortgages or other loans.
DTI can also fluctuate greatly by age. As people get older, they may start a family, buy a home, switch to a larger vehicle, renovate their home and take other debt-creating actions. A CNBC report showed huge generational swings in total debt. Here’s how debt changes by generation:
- Generation Z (18 to 23 years old): $9,593
- Millennials (24 to 39 years old): $78,396
- Generation X (40 to 55 years old): $135,841
- Baby Boomers (56 to 74 years old): $96,984
- Silent generation (75 years old and up): $40,925
The other side of the coin is that income will also vary by age. Your lowest-earning years are during the early stages of your career. As you move deeper into your career, the average salary increases. Then, as you enter retirement, your yearly income will generally drop again.
The average disposable household income by generation is as follows:
- Generation Z: $26,565
- Millennials: $70,565
- Generation X: $90,964
- Baby Boomers: $72,201
- Silent generation: $40,323
While these numbers don’t actively lay out the DTI, as that requires knowing the monthly payments each generation is making, this does show how many people will increase their debt along with their income. This points toward a relatively steady DTI throughout one’s lifetime.
If your DTI is too high and keeps you from getting the loan you need, there are strategies to help lower it quickly.
Refinancing may be the quickest way to lower your DTI and get approved for a loan. If you have a loan with a high nterest rate or a short repayment term, you can attempt to refinance that debt into a lower-interest loan or one with a longer repayment term to lower the monthly minimum payment.
The only downside to this is extending your repayment period may get you a lower payment, but it will likely increase the amount of interest you pay over time.
If you have multiple credit cards, and their minimum monthly payments result in a higher DTI, debt consolidation may be a good option. Not only does debt consolidation typically result in a lower interest rate than most credit cards, but it can also reduce your overall monthly debt payments.
The tradeoff is that some debt consolidation loans include origination fees, which can be thousands of dollars. Plus, you generally need a good credit score and credit history to get approved for the best terms.
If the new car loan or home loan you’re considering will push your DTI too high for your lender to approve, you can increase your down payment to lower the monthly payment. This could reduce your DTI just enough for the lender to approve you.
If your DTI is too high, you can also pause your loan search and focus on repaying your debt as quickly as possible. You can streamline this process using either the debt avalanche or the debt snowball method.
The debt avalanche method wipes out your highest-interest debts first, saving you on interest charges. If you choose the debt snowball method, you’ll focus on the smallest debts first to help keep you motivated.
You could also use a line of credit to pay down debt. Lines of credit are revolving, meaning you can use them multiple times, with interest rates generally lower than a credit card. You could pay off one or more cards at a time using a line of credit and steadily reduce your DTI.
A good DTI is an important factor when getting approved for a new loan, whether it’s a car loan, mortgage, personal loan or business loan. But what is a good debt to income ratio?
That really depends on the lender‘s standards, but anything under 36% is typically considered a good DTI and under 43% is an acceptable DTI.
With a DTI of 43% or higher, you may run into issues getting approved.
Fortunately, there are ways to lower your DTI relatively quickly, including:
- Debt consolidation
- An increased down payment
- Debt repayment
With these DTI-reducing options, you may be able to rein in your monthly debt payments and get the loan approval you need.
If you’re looking to reduce your DTI, Tally1 can help you pay off higher-interest credit card debt. Plus, its credit card repayment app will make all your credit card payments for you. You’ll only make a single monthly payment to Tally, and it handles disbursing the payments to your credit cards.
1To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate.