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Debt-to-income ratio explained, plus how to calculate yours

Your debt-to-income ratio is an important factor lenders look at when approving you for new credit.

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Before approving you for new credit, lenders will likely first look at your credit report, your credit score and something called your debt-to-income ratio — commonly referred to as DTI.

While all these factors help show your likelihood to repay the money you borrow, your DTI shows whether or not you have the means to actually afford repayment. As it's expressed, a "debt-to-income" ratio is how much debt you have relative to your income.

Lenders look at your DTI to see what amount of your monthly income goes toward the debt obligations you already have. A low DTI indicates that you earn more than you owe, whereas a high DTI means that more of your paycheck goes toward paying your debts.

How to calculate your debt-to-income ratio

To calculate your DTI, divide your total monthly payments (credit card bills, rent or mortgage, car loan, student loan) by your gross monthly earnings (what you make each month before taxes and any other deductions).

For example, here's what your monthly payments may look like:

Mortgage: $1,500

Car loan: $500

Student loan: $320

Credit card minimum payment: $180

Total monthly bill payments: $2,500

If your monthly debts total $2,500 and your gross monthly income is $5,000, your DTI calculation would look like: $2,500 / $5,000 = 0.5. To get the ratio as a percentage, you would then multiply 0.5 x 100 = 50%. Your DTI would be 50%.

The ideal DTI varies by lender, type of loan and loan size. Generally, a DTI of 20% or less is considered low and at or below 43% is the rule of thumb for getting a qualified mortgage, according to the CFPB. Lenders for personal loans tend to be more lenient with DTI than mortgage lenders. In all cases, however, the lower your DTI, the better. A lower DTI shows you make more than you owe and can therefore afford to take on more debt while keeping up with the monthly payments you already have.

How to improve your debt-to-income ratio and help your credit score

Your income isn't included on your credit report, but lenders will often ask you to include it on any loan application, as well as show proof of income.

Because your DTI doesn't show up on your credit report, it won't necessarily affect your credit. Actions you take to lower your DTI, however, can in turn help your credit score.

One obvious way to lower your DTI is to reduce your total debt load. If you can, pay off your credit card balances or any other loans, or at least chip away at the balances when possible. Getting rid of your outstanding credit card debt also helps to lower your credit utilization rate, which looks at how much of your available credit you use. A low utilization rate is essential to having a good credit score, and it makes up 30% of your score calculation.

A debt consolidation loan might make it easier for you to reduce your debt faster by streamlining your monthly credit card payments into one bill. Qualifying for a lower monthly payment can also help to lower your monthly debt obligations, and thus lower your DTI. We rated the Marcus by Goldman Sachs Personal Loan best for debt consolidation for offering no origination fees, no early payoff fees and no late fees.

Keep track of your credit score as you improve your debt-to-income ratio

Since your credit score plays a big role in whether or not you get approved for new credit, keeping track of it is just as important as working on improving your DTI.

Credit monitoring services help you stay alert of any changes to your credit by notifying you in real time, as well as helping you spot fraud early on. CreditWise® from Capital One is a free credit monitoring service that is open to anyone — regardless of whether you're a Capital One cardholder. It also offers dark web scanning and social security number tracking, plus a credit score simulator tool. As you plan to pay off any debt in hopes to improve your DTI, you can see how these efforts also help your credit score.

Increasing your income is another way to improve your DTI. Consider asking for a raise at work, finding a side hustle you can do at nights or on the weekends or leaving your job for one that pays you more.

Keep in mind that when you do get approved for that new credit you've been wanting, your DTI will increase since you are taking on more debt. This can influence your ability to borrow more in the future.

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