8 min read
Improving Your Debt-to-Income Ratio
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In Q3 2024, Americans spent 11.3% of their disposable income on household debt payments (St. Louis Fed, 2024). Still, some households suffer massive debts, using over 50% of income to service debt. When your debt payments consume too much of your monthly income, lenders view you as a riskier borrower. This results in unfavorable loan terms, higher interest rates, or loan denials.
Understanding how to improve your debt-to-income ratio helps you qualify for better financing options. In simple terms, your debt-to-income ratio (DTI) computes the percentage of your income that goes toward paying debts each month. In this article, we’ll explain how to compute your DTI ratio, what is a good debt-to-income ratio, the best debt-to-income ratio for various loans and strategies for lowering it.
Lesson Notes:
- Debt-to-income is a percentage measure of your monthly debt against income.
- Lenders use DTI to gauge your capacity for more debt.
- A DTI below 36% increases chances of loan approval and lower rates.
- Pay down debts and increase your income to boost your DTI.
LESSON CONTENTS
What is a debt-to-income ratio and why is it important?
Your debt-to-income ratio is the fraction of your monthly gross income that services your debt repayments. To calculate it, sum up all your monthly debt obligations — such as mortgage payments, car loans, student loans, court-ordered fixed payments like child support, and credit card minimum payments — and then divide that figure by your gross monthly income. Multiply by 100 to get a percentage. For example:
Total Monthly Debt Payments: $1,800
Gross Monthly Income: $5,000
DTI Ratio = ($1,800 ÷ $5,000) × 100 = 36%
Why is DTI so crucial?
This ratio is vital because it gives lenders a snapshot of your capacity to take on additional debt. Credit unions, banks, and other financial institutions use DTI as a primary factor to evaluate your creditworthiness. A high DTI means your finances are already strained, and you can’t handle more debt.
What is a good debt-to-income ratio?
Different lenders have varying thresholds for an acceptable DTI, but financial experts generally recommend keeping it as low as possible. Most industry professionals consider 36% or lower ideal, which is often cited as the best debt-to-income ratio range for securing favorable loan terms. A DTI in the 37–43% range may still be acceptable, but it could limit your access to the most competitive interest rates.
- DTI under 36%: Often viewed as the “sweet spot.” You’ll likely qualify for a wide range of lending options with favorable rates.
- DTI between 37% and 43%: You might still get approved, but some lenders will charge a higher interest or request a larger down payment.
- DTI above 43%: This is a red flag for many lenders, especially mortgage providers. You’ll likely need to lower your debt or increase your income to qualify for new credit.
As a rule of thumb, the lower your DTI ratio, the higher your chances of approval — at better terms. The Consumer Financial Protection Bureau recommends that homeowners with mortgage payments maintain a DTI ratio of 36% or less. On the other hand, renters should keep it at 15-20% or less, where rent payments aren't included in the ratio (CFPB, 2023).
How to lower your debt-to-income ratio
Improving your DTI is one of the most important steps you can take to make yourself a more attractive borrower. If you’ve ever wondered how to lower your debt-to-income ratio, below are concrete actions you can start implementing right away.
- Pay down high-interest debts
High-interest debts, particularly credit card balances, can quickly inflate your monthly debt payments. Prioritizing these debts with the avalanche or snowball approach helps you pay them off faster:
- Avalanche Method: Target the highest interest rate debt first, while contributing minimum payments on others.
- Snowball Method: Under this approach, start with the smallest balance to build momentum and motivation, while contributing minimum payments on others.
- Increase your income
Another approach is maintaining the same monthly debt payment while boosting your gross income. U.S. employers plan to increase salaries by 3.7% in 2025 (Mercer, 2024). So, if you haven’t had a raise in the past year, it might be time to negotiate one. Besides asking for a raise, pursuing a new job opportunity, or taking on a side gig can boost income, lowering your DTI.
- Refinance or consolidate loans
Refinancing can make a consequential difference in your debt payments. If you lock in a lower interest rate or extend your loan term, your monthly obligations will decrease, thereby improving your DTI. Also, consolidating multiple debts into one loan at a lower rate reduces the total amount you pay each month. This is a smart step in how to improve your debt-to-income ratio quickly.
- Avoid new debt
Lastly, an essential yet overlooked strategy for getting out of debt: steer clear of taking on new debt until you’ve reduced existing balances. Focus on paying off or significantly lowering your current debts before adding more.
Preparing your finances for future loan approval
If you’re planning to buy a home, invest in a new car, or consolidate debt, prepare your finances in advance. Improving your DTI is just one piece of the puzzle. Here are a few other things to consider:
- Build up emergency savings: Save where possible. Aim for three to six months’ worth of expenses in a liquid savings account. This buffer will prevent you from going into more debt when emergencies hit.
- Improve your credit report: Check your credit report from www.annualcreditreport.com – you are entitled to a free one from each of the three national credit reporting companies every 12 months. Improve your credit score by paying bills on time, lowering credit utilization, and disputing errors to secure better loan terms.
- Create a budget: Know where all your income goes each month. This way, you can see where to cut back and direct more towards debt repayment.
How your DTI affects your credit union loan applications
Credit unions offer more flexible loan terms and lower rates compared to traditional banks. However, they still evaluate your DTI to gauge whether you can handle monthly payments. A lower DTI below 36% opens doors to an array of loan products, including personal loans, auto loans, and mortgages. Also, you enjoy better rates and more forgiving eligibility criteria.
By knowing what a good debt-to-income ratio is and actively working to lower your own, you set yourself up for greater financial flexibility. For example, if you aim to secure a mortgage or refinance an existing loan, credit unions will review your credit history and score, employment history, and DTI. Demonstrating a lower DTI ratio highlights your financial discipline, ultimately helping you stand out as a responsible borrower.
Smart money habits to maintain a healthy DTI
After learning how to improve your debt-to-income ratio, you must also understand how to maintain it. Keep these habits to maintain a healthy DTI and avoid getting back on the hamster wheel of debt:
- Automate bill payments: First and foremost, set up automatic payments. They are the antidote to late fees and penalties, which can lead to higher overall debt.
- Regularly review your budget: Make adjustments as your financial situation changes, such as a job shift or new monthly expense.
- Avoid impulse purchases: Stick to a list or use a “cooling-off” period before big buys to prevent unnecessary debt.
- Plan for major expenses: If you anticipate expenses like home renovations or buying a new car, save in advance.
- Stay informed: Watch interest rate trends and refinance options. If rates drop, consider refinancing high-interest debt.
FAQs
- How do I calculate my debt-to-income ratio accurately?
Add up all your recurring monthly debt payments — mortgage, car loan, student loans, minimum credit card payments — then divide the aggregate total sum by your gross monthly income (amount before taxes and deductions). Multiply by 100 to get the percentage. For a $2,200 total monthly debt load and a gross income of $5,500, your DTI is 40% (2,200 ÷ 5,500 × 100).
- What types of debt are included in my DTI ratio?
Generally, any recurring monthly debt payment is included: mortgage, auto loans, personal loans, student loans, and credit card minimum payments. Lenders also include court-ordered monthly payments like alimony and child support. However, discretionary spending (like groceries or utility bills) is usually not counted.
- Will reducing my DTI improve my credit score too?
While they are closely related, your DTI and credit score measure different aspects of your financial health. Lowering your DTI can indirectly improve your credit score if you reduce credit card balances (because this lowers your credit utilization ratio). However, your credit score also factors in payment history, credit mix, and credit history length.
- How quickly can I lower my DTI to qualify for a loan?
The timeline varies depending on your existing debts and how aggressive you are in paying them down. You can manage to lower your DTI within weeks by consolidating debts, negotiating higher pay at work or boosting income via a side hustle. Or you may need a year or more of debt paydowns to see substantial results.
- Does refinancing or consolidating loans help reduce my DTI?
Absolutely. Lowering your monthly payment through refinancing or consolidation means a smaller debt obligation each month. However, keep in mind you might extend your loan term, which might increase the total interest paid over the life of the loan.
Citations
Consumer Financial Protection Bureau (2023). Debt-to-income calculator tool. https://files.consumerfinance.gov/f/documents/cfpb_your-money-your-goals_debt_income_calc_tool_2018-11_ADA.pdf
Mercer (2024, December 10). Despite economic uncertainty, US employers maintain elevated compensation budgets for 2025, according to Mercer. https://www.mercer.com/en-us/about/newsroom/us-employers-maintain-elevated-compensation-budgets-for-2025/#:~:text=According%20to%20the%20survey%20of,non%2Dunionized%20employees%20in%202025.
St. Louis Fed (2024, December 20). Household Debt Service Payments as a Percent of Disposable Personal Income (TDSP). https://fred.stlouisfed.org/series/TDSP
*PLEASE NOTE: This article is intended to be used for informational purposes and should not be considered financial advice. Consult a financial advisor, accountant or other financial professional to learn more about what strategies are appropriate for your situation.
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