If you need money, you may be considering a loan. Whether you’re looking to consolidate debt, pay for unplanned emergency expenses, give your small business some additional cash flow, or use extra money for another purpose, understanding what is included in your debt-to-income ratio is important when determining how likely you are to qualify.
A loan is often an effective solution for meeting your financial needs. Your existing financial obligations in particular lead to a measurement called your “debt-to-income ratio,” which allows the lender to assess your risk and determine whether you’ll be able to repay the money you borrow.
When you apply for a loan, your lender looks at several factors:
- Credit score
- Credit history
- Employment history
- Income information
- Existing financial obligations
What Is a Debt-To-Income Ratio?
When understanding what is included in your debt-to-income ratio, it’s important to know how much total debt you have divided by much income you bring in. Lenders use this information to determine your level of risk. A lower ratio typically means you’re less of a risk because you’re more likely to be able to make your loan payment in addition to your current debt obligations.
Does My Debt-To-Income Ratio Affect My Credit Score?
No, your debt-to-income ratio does not impact your credit score.
Credit reporting agencies don’t look at your income. Instead, they use your debt-to-credit: the amount of credit you currently use versus how much available credit you have.
While folks with high debt-to-income ratios often have high credit utilization, which accounts for 30% of your credit score, this isn’t always the case. If both your utilization and debt-to-income ratio are high, working to lower your utilization may help lower your debt-to-income ratio.
How to Calculate Your Debt-To-Income Ratio
To calculate your debt-to-income ratio, divide the sum of your debts by your gross (pretax) monthly income.
- Calculate your recurring debt payments: add all of your monthly debt obligations together, including your mortgage, minimum credit card payments, student loan payments, alimony, and child support payments.
- Calculate your monthly income: add all of your gross monthly income sources together, including your wages or salaries, bonuses, tips, pension, alimony and child support, and any other income amounts.
- Divide your recurring debt payments by your monthly income and multiply by 100 to get your debt-to-income percentage.
What’s Considered a Good Debt-To-Income Ratio?
In general, a good debt-to-income ratio is less than 35%.
- Less than 35%: your debt is considered manageable
- 36% to 49%: while manageable, there’s room to improve
- 50% or higher: you likely have little to no funds left at the end of the month
The maximum debt-to-credit ratio accepted by a lender varies from one company to another. Many lenders look for a ratio of 43% or less. Some look for ratios below 35%. Others will work with borrowers who have debt-to-income ratios of up to 50%
What Is Included in My Debt-To-Income Ratio?
Lenders consider a variety of debts when determining your debt-to-income ratio, but they don’t include everything.
Is Rent or Mortgage Included in Debt-To-Income Ratio?
Yes. Your housing payments, whether it’s monthly rent or a mortgage, are included in your debt-to-income ratio. Mortgage includes mortgage insurance, homeowner’s insurance, property taxes, and HOA fees.
Are Car Insurance Payments or Auto Loans Included in Debt-To-Income Ratio?
Monthly auto loan payments are part of your debt-to-income ratio. Your car insurance payments, however, are not.
What About My Credit Card Payments?
Your minimum monthly credit card payments are included in your debt-to-income ratio. However, any amount you pay over the minimum due is not included.
What if I Have Student Loans?
Your minimum monthly student loan payments are included in your debt-to-income ratio. If you are a co-signer but don’t make the monthly payments, your debt-to-income ratio may still be impacted because the loans appear in your credit report.
What Other Debts Are Included in My Debt-To-Income Ratio?
Several other types of debts can be included in your debt-to-income ratio, including:
- Personal loan payments
- Co-signed personal loan (or another loan) payments
- Child support
- Timeshare payments
What Debts Aren’t Included?
Some debts aren’t considered in the calculation, even if you pay the same amount each month. These debts include:
- Car insurance
- Health insurance
- Electricity, gas, and water
- Cable, phone, and internet
- Cell phone
While these payments aren’t included in your debt-to-income ratio, you should keep them in mind when figuring out how much money you have at the end of the month. Even if your debt-to-income ratio is acceptable, other monthly payments could make it difficult for you to afford an additional loan payment.
It’s essential to keep track of your finances. Creating a budget will help you monitor what you spend versus what you make more effectively.
What if My Debt-To-Income Is Too High?
If your debt-to-income ratio is high, you may be considered too much of a risk to qualify for a loan. This doesn’t mean you’re out of luck. There are ways to lower your debt-to-income ratio and increase your odds of loan approval.
- Pay down existing debts. Pay more than your minimum monthly payments or employ a strategy such as the snowball method.
- Don’t take on any new debts.
- Use a balance transfer to a new card with a 0% introductory rate. Make sure that you can pay off the balance before the end of the payment period to avoid accruing interest.
- Increase your income by asking for a raise or taking on a second job or side hustle.
If you learn how to get a loan with high debt-to-income ratio but decide to pursue loan alternatives, a sale-leaseback could be a good fit for you. Through these programs, you can sell your house and get the funds you need. The best part is that you don’t have to move! Instead, you get to stay as a renter—you simply pay rent as a tenant. Should you decide to repurchase your home in the future, you can.
If you need money for any reason, but a high debt-to-income ratio is keeping you from getting a loan, there are options available. Talk to a financial expert about how to improve your debt-to-income ratio.