A “good” Debt to income ratio depends on lender standards and your financial goals. But there are widely accepted ranges that indicate your financial health and borrowing potential.
DTI Ratio Ranges and What They Mean
Here’s a breakdown of DTI ranges, their labels, and the implications for borrowing;
| DTI Range | Verdict | Favorable Conditions |
|---|---|---|
| 0% – 15% | Excellent | Best interest rates, premium credit cards, low-rate mortgages, auto loans, and personal loans. |
| 16% – 25% | Very Good | Competitive mortgage rates, good credit card rewards, low-rate personal and auto loans. |
| 26% – 35% | Good | Standard loan rates, good auto loans, personal loans, solid credit card options. |
| 36% – 45% | Fair | Average loan rates, limited credit card options, higher down payments may be required. |
| 46% – 50% | Risky | Higher-interest mortgages, personal loans with higher rates, limited credit cards. |
| 51% and Above | Very Risky | Subprime mortgages, high-interest personal loans, secured credit cards or loans. |
DTI Ratio of 35% or below:
This is considered a healthy, manageable range. At this level, your debt load is likely under control, and lenders view you as a low-risk borrower.
DTI Ratio between 35% and 49%: This range is more of a warning sign. While you might still manage your debts, you’re approaching a risky level that could raise concerns with lenders, especially if you’re looking for more credit or a loan.
DTI Ratio of 50% or higher: This is a high-risk level. Lenders may be reluctant to extend additional credit, and you might struggle to meet your financial obligations. It’s a sign to focus on reducing your debt load.
Example of a DTI Calculation (Based on Net Income)
Let’s break down an example using net monthly income:
Step 1: Add Up Monthly Debt Payments
- Mortgage: $1,200
- Car Loan: $300
- Credit Card Payment: $150
- Personal Loan: $200
- Total Monthly Debt Payments: $1,850
Step 2: Calculate Net Monthly Income
Let’s say your total monthly net income after taxes and deductions is $5,500.
Step 3: Apply the DTI Formula
The DTI ratio is calculated using this formula:
DTI Ratio = (Total Monthly Debt Payments / Net Monthly Income) * 100
So in this case; DTI Ratio = (1,850 / 5,500) * 100 = 33.64%
With a DTI ratio of 33.64%, you’re in a good range, well below the 35% threshold. This suggests that your debt load is manageable, and you would likely have a good chance of getting approved for a loan if needed. But the lower your DTI score, the better your chances to get favorable loan rates.
Want to calculate your DTI based on your income? Use this free DTI Calculator to check where you stand.
Why Net Income Is Better Than Gross Income for DTI Calculations
While some lenders might use your gross income (income before taxes) to calculate the DTI ratio, using net income (income after taxes and deductions) provides a more accurate reflection of your financial situation. Here’s why:
- Realistic Budgeting: Your net income represents what you actually take home each month, making it a more realistic measure of what you can afford to spend on debt payments. Gross income can give a false sense of affordability because it doesn’t account for taxes and other deductions.
- More Accurate Financial Health: If you calculate your DTI ratio based on gross income, you might underestimate how much of your take-home pay is being eaten up by debt. This could lead you to take on more debt than you can comfortably handle, increasing the risk of financial strain.
- Better Debt Management: Using net income helps you set more practical limits for your debt obligations, so you’re less likely to overextend yourself. This ensures you have enough leftover income to cover essential expenses like rent, groceries, and savings.
Bottom Line
A good debt-to-income ratio is typically 35% or lower, calculated using your net income for accuracy. This range shows lenders you’re a low-risk borrower, opening doors to favorable loan terms and interest rates.
Keeping your DTI in check ensures you can comfortably manage debt while covering other expenses and building savings. Regularly calculate your DTI, monitor your finances, and take steps to improve it for a stronger financial future.
When calculating your DTI ratio, it’s best to use net income to get a more accurate picture of how much of your take-home pay is going toward debt. This approach gives you a clearer understanding of your financial health and helps you make more informed decisions about borrowing and budgeting.
