Why Debt-to-Income Ratio Matters

A high debt-to-income ratio can torpedo your chances for a loan. Vitalii Vodolazskyi/Shutterstock

Many Americans struggle with debt. But this debt can hinder personal finances in more ways than one. That’s because if you have too much debt in relation to your income, it might keep you from qualifying for a loan.

The number determined by this relationship between debt and income is called the debt-to-income ratio (DTI). And it can determine your financial future. Here’s why it’s so important and what you can do about it.

Understanding Debt-to-Income Ratio

According to Wells Fargo, more than 40 percent of Americans are trying to find ways to overcome debt to help their personal finances. The two vital numbers that affect financial health are credit score and the DTI ratio. And although most people know that a good credit score is vital, many don’t realize a DTI can nullify it.

Your DTI compares your monthly debt payments to your monthly gross income. In other words, it calculates what percentage of your paycheck goes toward paying debt.

To determine your DTI, take the total amount of debt payments you owe every month and divide it by your gross monthly income. For example, if you have $2,500 in monthly debt and $5,000 in gross monthly income, your DTI would be 50 percent.

What Is Included in a DTI Ratio

All income, including child support or alimony, must be factored into your DTI. Other income included is W2 income, pensions, recurring payments from lottery winnings, Social Security benefits, etc. In other words, income that is consistently generated monthly.

Debt must also be factored into a DTI. Home loans and revolving debt are part of the equation.

You’ll need to factor in housing expenses such as mortgage, rent, Homeowners Association (HOA) fees, and maintenance fees

Revolving debt will also need to be considered. This is the one that often hurts people. According to TransUnion, in the fourth quarter of 2024, Americans’ average credit card debt per borrower was $6,580. So, credit card debt is a major component of a DTI ratio.

The good news is that the total credit card balance isn’t factored into the DTI ratio. Only the monthly minimum payment is counted. So, if your minimum payment is $100 per month, the $100 will be factored into your DTI ratio.

Other revolving debt could be a home equity line of credit (HELOC) payment. Just like the credit card, only the monthly payment is counted. If you have any other line of credit minimum payments, they are also used to determine the DTI ratio.

Installment-loan payments are factored into a DTI ratio. These could include:

• student loan payments
• personal loan payments
• auto loans or lease payments
• co-signed loan payments
• IRS installment agreement payments

Other debt obligations could include child support payments, time-share payments, or any court-ordered payments.

What Is Not Included in a DTI Ratio

Your DTI won’t include some of your income. For example, income that a DTI ratio doesn’t take into account includes:

• one-time payments
• temporary income sources that end soon
• unverifiable cash income without documentation

For example, freelancers and people paid in cash often have difficulty with their income being included in a DTI ratio. They may need to show detailed documentation such as bank statements, two years of tax returns, as well as 1099-K.

Some debts or expenses are often not counted in a DTI ratio. For example, utilities, insurance premiums, and child care expenses (unless through a loan) are not included.

Medical bills that are not financed through a loan are not a factor.

Why You Need a Good DTI

Lenders use the DTI ratio to learn how much of your income is going to debt. The lenders can then determine how much more debt you can handle. They want to see a low DTI ratio, but a good DTI ratio varies by product and by lender.

For example, according to Wells Fargo, most lenders generally don’t want to see more than a 36 percent DTI to be approved for a mortgage. Other mortgage lenders may allow 43–45 percent. Loans insured by the Federal Housing Administration (FHA) allow up to a 50 percent DTI ratio.

Does a DTI Ratio Affect a Credit Score?

A DTI ratio isn’t used to calculate a credit score. However, factors that contribute to your DTI ratio will impact your credit score. For example, high credit card balances negatively impact both your credit score and your DTI ratio.

However, the debt-to-income ratio is sometimes confused with the debt-to-limit (DTL) ratio; it is also called the utilization ratio. And it is the second biggest factor in calculating credit scores. The DTL ratio is how much of your total credit you use.

How to Lower a DTI Ratio

If you have a DTI ratio higher than 36 percent, consider taking steps to reduce it. Make a plan to start increasing the amount you pay toward your debts monthly. Contact your creditors and ask if they will reduce your interest rate. This may save you enough to make bigger payments.

Avoid taking on more debt. And if you can, increase your income. You may need a side hustle or extra job.

Check your DTI ratio periodically to see if you’re making progress.

Vigilance Is Key

A high debt-to-income ratio can torpedo your chances for a loan. Whether it’s a mortgage or a HELOC, lenders factor in your DTI ratio to determine if you qualify. But it’s a number you can control if you are vigilant about avoiding debt.

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