Debt-to-Income Ratio vs. Debt-to-Credit Ratio
Reading time: 3 minutes
- Debt-to-credit and debt-to-income ratios can help lenders assess your creditworthiness.
- Your debt-to-credit ratio may impact your credit scores, while debt-to-income ratios do not.
- Lenders and creditors prefer to see a lower debt-to-credit ratio when you're applying for credit.
When it comes to credit scores, credit history and credit reports, you may have heard terms like "debt-to-income ratio” and “debt-to-credit ratio.” But what do these terms mean, and more importantly, how are they different?
What is your debt-to-income ratio?
Your debt-to-income ratio (DTI) refers to the total amount of debt payments you owe every month divided by the total amount of money you earn each month. A DTI ratio is usually expressed as a percentage.
This ratio includes all of your total recurring monthly debt — credit card balances, rent or mortgage payments, vehicle loans and more.
How is your DTI ratio calculated?
To calculate your DTI ratio, divide your total recurring monthly debt by your gross monthly income — the total amount you earn each month before taxes, withholdings and expenses.
For example, if you owe $2,000 in debt each month and your monthly gross income is $6,000, your DTI ratio would be 33 percent. In other words, you spend 33 percent of your monthly income on your debt payments.
Why does your DTI ratio matter?
Lenders may consider your DTI ratio as one factor when determining whether to lend you additional money and at what interest rate. Generally speaking, the lower a DTI ratio you have, the less risky you appear to lenders. The preferred maximum DTI ratio varies. However, for most lenders, 43 percent is the maximum DTI ratio a borrower can have and still be approved for a mortgage.
How to lower your DTI ratio
If you have a high DTI ratio, you're probably putting a large chunk of your monthly income toward debt payments. Lowering your DTI ratio can help you shift your focus to building wealth for the future.
Here are a few steps you can take to help lower your DTI ratio:
- Increase the amount you pay each month toward your existing debt. You can do this by paying more than the minimum monthly payments for your credit card accounts, for example. This can help lower your overall debt quickly and effectively.
- Avoid increasing your overall debt. If you feel it's necessary to apply for additional loans, first aim to reduce the amount of your existing debt.
- Postpone large purchases. Prioritize lowering your DTI ratio before making significant purchases that could lead to additional debt.
- Track your DTI ratio. Monitoring your DTI ratio and seeing the percentage fall as a direct result of your efforts may motivate you to continue reducing your DTI ratio, which can help you better manage your debt in the long run.
What is your debt-to-credit ratio?
Your debt-to-credit ratio, also known as your credit utilization rate or debt-to-credit rate, represents the amount of revolving credit you're using divided by the total amount of credit available to you.
Revolving credit accounts include things like credit cards and lines of credit. They don't require a fixed payment each month, and you can re-use the credit as you pay your balance down. On the other hand, installment loans are things like a mortgage or a vehicle loan, with a fixed payment each month. When installment loans are paid, the account is closed. Installment loans generally are not included in your debt-to-credit ratio.
How is your debt-to-credit ratio calculated?
You can determine your debt-to-credit ratio by dividing the total amount of credit available to you, across all your revolving accounts, by the total amount of debt on those accounts.
For example, say you have two credit cards with a combined credit limit of $10,000. If you owe $4,000 on one card and $1,000 on the other for a combined total of $5,000, your debt-to-credit ratio is 50 percent.
Why does your debt-to-credit ratio matter?
Many lenders use credit scoring formulas that take your debt-to-credit ratio into consideration. In general, lenders like to see a debt-to-credit ratio of 30 percent or lower. If your ratio is higher, it could signal to lenders that you're a riskier borrower who may have trouble paying back a loan. As a result, your credit score may suffer.
What's the difference between your debt-to-credit ratio and your DTI ratio?
Debt-to-credit and DTI ratios are similar concepts; however, it's important not to confuse the two.
Your debt-to-credit ratio refers to the amount you owe across all revolving credit accounts compared to the amount of revolving credit available to you. Your debt-to-credit ratio may be one factor in calculating your credit scores, depending on the scoring model used. Other factors may include your payment history, the length of your credit history, how many credit accounts you've opened recently and the types of credit accounts you have.
Your DTI ratio refers to the total amount of debt you carry each month compared to your total monthly income. Your DTI ratio doesn't directly impact your credit score, but it's one factor lenders may consider when deciding whether to approve you for an additional credit account.
Familiarizing yourself with both ratios may give you a better understanding of your credit situation and help you anticipate how lenders may view you as you apply for credit.