DTI: Debt-to-Income Ratio and How to Improve It
“I needed a substantial amount ($20,000) for debt consolidation. Try getting an unsecured loan for this amount through your local bank. Not going to happen unless you have super excellent credit and an extremely low debt to income ratio. My initial attitude towards LendingClub because of the amount I needed was ‘Yeah, right. This will be a rejection.’ Nope. The loan was approved and the money was deposited into my account in less than a week. I will use LendingClub again for my future borrowing needs and I would definitely recommend them to my friends and family. Thank you LendingClub.” —Daniel, a member from Indiana
What exactly is a debt-to-income ratio?
Debt-to-income ratio (DTI for short) is a simple calculation banks and other financial companies use to see if you are going to be able to pay back their loan. It’s the amount of your monthly debt obligations divided by your monthly income.
Why is DTI important?
Lenders and financial companies are most concerned about your ability to pay them back. Generally speaking, they lose money if you default on your loan, so they are cautious with their cash. If your debt-to-income ratio is too high, you might not be able to make the payments and the lender loses their money. That’s a lose-lose for everyone, since your credit score will take a serious hit.
How do you calculate your debt-to-income ratio?
Add together all your monthly debt payments. Leave out utilities, cell phone bills, and other non-loan payments. Common examples are:
- Car loans
- Minimum monthly payments on credit cards
- Student loans
- Other recurring debt payments (eg, personal loans)
Divide your monthly loan payments by your gross monthly income (how much you get paid before taxes). That number is your debt-to-income ratio.
Remember: gross income is not your take-home pay. Take-home is the amount after taxes, contributions to health insurance, 401(k), and the like. Lenders use gross income to calculate DTI.
If your loan payments add up to $1,000 per month and your gross income is $5,000, your debt to income ratio is 20%. 1,000/5,000 = 20%
How do you know if your debt-to-income ratio is too high?
Ideally, your debt-to-income ratio would be lower than 40%. That’s generally the threshold used across the industry. If your DTI is higher than 40%, your loan application will likely be denied.
How do you improve your debt-to-income ratio?
There are several ways to do it, but they come down to either increasing your income or decreasing your debt. Some concrete ways to do this include:
- Make sure you're calculating all of your income sources—Did you forget to include your overtime, bonuses, or child support?* Make sure you can provide proof of that before you include it.
- Take on a side hustle for a couple of months—Use the extra income to pay down more of your debt, and increase your income relative to it. Voila!
- If you can, pay down some debt—Maybe you can’t change your income, but you have a decent chunk of savings. Paying down your debt can improve your DTI very quickly.
*reporting additional income such as alimony or child support is voluntary.