What is a good debt-to-income ratio?
Debt-to-income (DTI) ratios probably aren't something many people think about often. But it's important not to discount this ratio and the impact it can have on your financial stability. After all, your DTI ratio typically plays a significant role in your ability to access loans - or lack thereof.
Calculated by dividing your total monthly loan payment obligations by your gross monthly income (income before taxes and deductions), this ratio gives lenders an idea of whether or not you can afford to take on more debt; and if you can, how much risk they accept when they loan money to you. In turn, your DTI ratio plays an important role in whether or not you will qualify for new loans and the interest and payment terms you'll qualify for if you do. But, what is a good DTI ratio?
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What is a good debt-to-income ratio?
You'll typically need a DTI ratio below 43% to qualify for loans with the best terms, according to Money. That said, some lenders may require a lower ratio for loan approvals. That means, if you earn $60,000 per year ($5,000 per month), you shouldn't have more than $2,150 in monthly loan payment obligations (43% of $5,000).
But that doesn't mean you should add debt to your budget until you reach a 43% DTI ratio. The lower this number is the better. Moreover, if your ratio is too high, you should take action to reduce it immediately. You never know when you'll need a new loan and a high DTI ratio could hamper your chances of approval.
Have a DTI ratio over 43%? You may qualify for debt relief help here.
What to do if your debt-to-income ratio is too high
A high DTI ratio is a cause for concern because it can limit your borrowing options and lead to strain on your budget. But there are ways to bring your ratio down. Since the ratio compares your total debt to your total income, you could reduce your it by paying off some debt or increasing your income.
On the other hand, if you have a high DTI ratio, getting ahead of your debts may be easier said than done. After all, a high ratio means a significant portion of your income is already being used to make your minimum payments - leaving little left for extra payments toward principal. If that's the case for you, it may be time to reach out to a debt relief service.
Debt relief services - like debt management and debt forgiveness programs - typically help borrowers by negotiating their interest rates and payment terms or their principal balances with their lenders. Their goal is usually to modify your debts in such a way that you can pay them off in a reasonable amount of time without stretching your budget too thin. And as you pay your debts off, your DTI ratio will fall.
Why is it important to maintain a good debt-to-income ratio?
There are a few reasons why it's important to maintain a good DTI ratio, including:
- You never know when you will need a loan: You never know when a surprise expense will pop up - and when one does, you may need a loan to cover it. If you maintain a good DTI ratio, you'll have a higher probability of approval when the need for a loan arises.
- Loan terms are typically better for applicants with a good DT ratio: Loan terms are typically better for low risk borrowers than they are for high risk borrowers. Since those with a low DTI ratio have a higher percentage of their income available to pay for new loans, lenders take on less risk when funding those loans than they would if the borrower had a high ratio. So, you'll likely enjoy access to lower interest rates and more flexible terms when you seek borrowing options.
- You'll be more financially stable with a lower DTI ratio: Having a lower DTI ratio isn't just to ensure you have access to loans in the future; it can also help improve your financial stability. After all, the higher your ratio, the more of your income you spend on loan payments and less money you have available for saving and investing. By maintaining a low ratio, you will keep some money in your budget free for retirement and other savings.
The bottom line
If you're looking for a loan, you'll likely need a DTI ratio of 43% or lower to qualify for reasonable terms. But, the lower it is, the better. That's not just the case in terms of your ability to borrow, but also in terms of your financial stability. If your ratio is higher than 35%, it's likely time to act. Consider contacting a debt relief provider to learn more about your options.
