Understanding Your Debt-to-Income Ratio

Published April 2021

Understanding how creditors evaluate your creditworthiness is one step in the right direction toward achieving your financial freedom. After all, knowledge is power, and knowledge of how financial matters work can help you make your way out of debt into financial stability.


Key Points: 

  • Ideally lenders prefer a debt-to-income ratio lower than 36 percent.
  • The lower the debt-to-income ratio, the better the chances a borrower will be approved.
  • To improve your debt-to-income ratio you need to increase your income or decrease your debt.

 

(Take one of our fun Debt IQ tests to test your knowledge now.)

One of the factors that impact your creditworthiness is your debt-to-income (DTI) ratio. What is it? How is it calculated? And what does it need to be for a person to be considered creditworthy? Here are the answers.

What is a debt-to-income ratio?

Your debt-to-income ratio is all your monthly debt payments divided by your gross monthly income. (Refresher tip: Your gross monthly income is the amount of money you earn before taxes and other deductions are taken out of your check.)

How is your debt-to-income ratio calculated?

This one’s easy. Just add up all your payments each month. Then add up all your gross income from all sources. Divide your payments by your income and you will get your ratio. The ratio is typically expressed as a percentage when lenders look at it.

What is a good debt-to-income ratio?

Lenders can set their own requirements regarding acceptable debt-to-income ratios, but usually, the ratios fall within some broad categories. For instance, if you are looking for a qualified mortgage, you need a debt-to-income ratio of no more than 43 percent. The Consumer Financial Protection Bureau states: “The 43 percent debt-to-income ratio is important because, in most cases, that is the highest ratio a borrower can have and still get a Qualified Mortgage.”

Investopedia has this to say about a good debt-to-income ratio: “Ideally, lenders prefer a debt-to-income ratio lower than 36 percent, with no more than 28 percent of that debt going towards servicing a mortgage or rent payment. The maximum DTI ratio varies from lender to lender. However, the lower the debt-to-income ratio, the better the chances that the borrower will be approved, or at least considered, for the credit application.”

Is your debt-to-income ratio part of your credit score?

Your debt-to-income ratio is important because it does factor into a lender’s decision about whether to approve your loan, but it is not technically a part of your credit score. Lenders use your credit score and credit reports in addition to your debt-to-income ratio to get a better picture of how you handle your finances. 

How can you improve your debt-to-income ratio?

If you are in the market for a loan, it makes sense to lower your debt-to-income ratio as much as possible to boost your chances of being approved for the loan at a good rate.

Since your debt-to-income ratio is only affected by your debt and your income, the only way to improve it is to either increase your income or decrease your debt (or both).

ClearOne Can Help You Improve Your Debt-to-Income Ratio

ClearOne Advantage may be able to help you improve your debt-to-income ratio in two ways. First, our team of negotiators may be able to negotiate with your creditors on your behalf to settle your debt and lessen the total amount of credit card debt you owe, lowering your debt-to-income ratio quickly. Second, as you work with ClearOne to make regular payments, you may be able to settle your credit card debts completely within 24 to 60 months, thereby lowering your debt-to-income ratios by a substantial margin. 

Call a ClearOne Certified Debt Specialist at 866-481-1597 and get a free savings estimate today.

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Topics: Financial Education