What Is a Good Personal Debt Ratio?

If you’ve applied for a home loan lately, you may have run across the term debt – income ratio. Lenders consider this, along with a number of other factors, when trying to determine your creditworthiness. The idea is to get a sense of how likely you are to be able to manage the payments on the loan you’re requesting so they can be assured you’ll repay the loan. 

So, what is a good personal debt ratio?

Let’s take a look.

What is a Ratio of Debt – Income?

 Debt – income ratio (DTI) is determined by dividing the total of all your monthly debt payments (mortgage/rent, auto loans  student loans,  child support, payments credit card etc.) by  gross monthly income (the money you earn before deductions). 

The average U.S. household has a gross income of $84,352 annually. That comes to roughly $7,029 monthly. Let’s say your monthly debt payments total $3,514.50. Dividing your debt by your income renders a DTI of 50%. Your DTI would equal 25% if your debt payments monthly is total $1,757. Debt payments of $878 monthly would render a DTI of 12%.

How Much is Too Much?

While the DTI standard varies from lender to lender, as well as the type of loan being requested, experts consider a DTI of 35% or less good.  A DTI falling between 49% and 36% is considered fair. A DTI of 50% or higher is usually considered a red flag. 

When you’re seeking a home loan, mortgage lenders want to see a 36% of DTI or less, within  28% of that 36% comprising the potential mortgage payment. On the high end, some lenders will consider a DTI of 43%, assuming all of the other factors determining your credit score look good. 

Reducing a DTI Ratio

Students of mathematics and people with basic common sense have by now surmised the best ways to improve a debt – income ratio. 

You can make more money, pay off some of your debt, or do both. 

Taking on a side gig, getting a raise at work, or finding a better-paying job can help improve your income. Creating a spending plan with an eye toward freeing up cash to pay down debt will help lower your monthly expenses. 

If you’re trying to purchase a home, or a car and your DTI is problematic, indulging fewer wants, focusing on your needs and using the additional cash to pay down debt will also help you get closer to your goal. The people at Freedom Debt Relief can show you how to get help with credit card debt, if paying it down proves too difficult to do on your own.

Your DTI and Your Credit Score

Strictly speaking, your DTI has no impact on your score of credit, as the credit reporting agencies don’t take your income into consideration. Instead, they look at how much credit you have available to you and measure that against how much of it is currently being used. 

For example, let’s say the total of all your credit limits comes to $20,000 and you have $5,000 in outstanding debts reported to the credit bureaus. In this instance, your credit utilization ratio will be 25%. Credit scoring algorithms consider anything above 30% to be problematic and will shift your score of credit downward accordingly. 

Again, when it comes to the question of what is a good personal debt ratio, it really depends upon the purpose of the question. The relevant answer will vary depending upon what you’re trying to do.