# What is the debt-to-income ratio and why is it important?

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## What is the debt-to-income ratio and why is it important?

Here’s how you can tell if your debt is out of proportion to your income

One of the foundations of good financial health is keeping your debt at a manageable level. But how do you know if your debt is getting out of control? Fortunately, there is a way to figure out if you have too much debt without waiting for the time when you can’t make your monthly payments or your credit score starts to decline.

## What is the debt-to-income ratio?

Your debt-to-income (DTI) ratio compares your monthly debt payments to your gross monthly income. When you apply for a home loan, auto loan, or any other type of loan, banks and other lenders use the ratio to help determine how much of your income is going toward your current debt obligations, and how much more you can afford. What Are Loan Proceeds?

## How is the debt-to-income ratio calculated?

To get started, add up all of your monthly debt payments. Include payments for:

Credit cards; use the minimum payment, even if you pay more than that amount

Any type of loan, such as auto, student, personal, and investment property

Housing expenses, either rent or mortgage payments plus interest, property taxes and insurance (PITI), and any homeowners association payments

Responsibilities such as alimony and child support

The next step is to determine your gross monthly income, which is your income before taxes and other deductions. Divide your monthly debt payments by your gross monthly income to get your ratio. Then multiply by 100 to get the percentage ratio.

Let’s say your debt payments total \$2,000 a month and your gross income is \$5,000 a month. Your debt-to-income ratio is \$2,000 divided by \$5,000, which equals 0.4, or 40 percent. Put another way, 40 cents of every dollar you earn goes toward paying off your debt.

## What is a good debt-to-income ratio?

The lower, the better your ratio. The preferred maximum DTI ratio depends on the product and varies by lender. For example, the approval limit for a mortgage is about 36 percent, although some lenders require as much as 43 percent. Generally, a ratio of 50 percent or more is considered an indicator of financial hardship.

## Can my debt-to-income ratio affect my credit score?

Not directly. The ratio itself is not used to calculate your credit score . However, the factors that contribute to your ratio can also affect your credit. For example, high balances on credit cards can affect both your debt-to-income ratio and your credit score. Likewise, low balances can help both.

## What is the difference between the debt-limit ratio and the debt-to-income ratio?

Both ratios use debt levels to help lenders assess risk. However, as their names suggest, they compare debt against different factors. The debt-to-limit ratio, also known as the credit utilization ratio, measures how much of your total available credit you are using. Lenders generally prefer credit card balances to be below 30 percent of  credit limits. Debt-to-limit ratio is the second most important factor in calculating credit scores, after payment history.

## How can you lower your debt-to-income ratio?

If your debt-to-income ratio is greater than 36 percent, you may want to take some steps to lower it. To do so, you could:

1. Make a plan to pay off your credit cards.
2. Increase the amount you pay monthly towards your debts. Making additional payments can help you reduce your total debt faster.
3. Ask your creditors to lower your interest rate, saving you money that you could use to pay off debt.
4. Avoid taking on more debt.
5. Find ways to increase your income.

One thing that can also help is to recalculate your debt-to-income ratio each month to see if you are making any progress. Watching it go down can help you stay motivated to keep your debt under control. improve your online business

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