Understanding how credit card debt affects your debt-to-income (DTI) ratio can make all the difference when planning your financial future. The DTI ratio is a number lenders use to weigh your ability to handle new debt.
If you’re carrying a significant balance on your cards, it can hold you back from achieving goals like buying a home, securing a car loan, or qualifying for better interest rates. Let’s explore what the debt-to-income ratio is, why it matters, how to calculate it, and exactly how credit card debt can sway this important number.
What is debt-to-income ratio?
Debt-to-income ratio, or DTI, compares the amount of debt you pay each month to your overall income. Lenders use it as a quick way to evaluate your financial health. If your DTI is too high, they may see you as too risky to lend more money to even if you pay your bills on time.
DTI doesn’t just measure one kind of debt. It includes things like:
- Your mortgage or rent
- Personal loans
- Auto loans
- Student loans
- Revolving debts like credit cards
Income typically includes your salary or wages before taxes (gross income), plus other consistent sources like bonuses, alimony, or side hustles.
How to calculate debt-to-income ratio
To figure out your DTI ratio, you need to know two things:
- How much you spend each month repaying debts (your total monthly minimum debt payments)
- How much money you bring in each month before taxes (your gross monthly income)
The formula looks like this:
DTI Ratio = (Total Monthly Debt Payments ÷ Gross Monthly Income) × 100
Let’s say you pay $1,500 per month toward your mortgage, $300 toward your auto loan, and $200 in minimum credit card payments. Your total monthly debt payments would be $2,000. If your gross monthly income is $5,000, your DTI would be:
($2,000 ÷ $5,000) × 100 = 40%
A DTI of 40% means that 40% of your monthly income goes to paying off debts.
How does owing money on credit cards factor into your DTI?
Credit card debt can have a powerful impact on your DTI ratio. Since lenders typically use the minimum payment required as the monthly obligation for DTI calculations, even moderate balances can noticeably increase your DTI. Multiple cards with minimum payments add up, especially if you’re only paying the minimum and carrying balances month after month.
A higher DTI may make it harder to qualify for loans or credit. For example:
- Mortgage lenders often require a DTI of 43% or less, with some preferring it below 36%.
- Auto loan providers might accept higher ratios, but the lower your DTI, the better your chances of getting favorable terms.
- Credit card issuers and personal lenders look at DTI to set your borrowing limits and interest rates.
Every new dollar of credit card debt increases your minimum monthly payment, which pushes your DTI higher.
Over time, if minimum payments rise because of added balances or higher interest rates, your DTI goes up. This leaves less room in your finances for emergencies, savings, or new debt you might need in the future.
How to determine debt-to-income ratio
Knowing how to calculate your debt-to-income ratio regularly can help you stay on top of your financial obligations and spot warning signs before you apply for new credit.
1. List all monthly debt payments
Include minimum required payments for:
- Credit cards
- Mortgage or rent
- Auto loans
- Student or personal loans
- Alimony/child support
2. Add up your total monthly debt payments
Write down the sum.
3. Calculate your gross monthly income
Use your pre-tax income, plus other regular sources if you have them.
4. Apply the DTI formula
Divide your total monthly debt by your gross monthly income, then multiply by 100.
What is a good debt-to-income ratio?
Most lenders agree on some general benchmarks:
- 36% or less is considered excellent, well within the safe zone
- 37%-43% is generally still acceptable, but you may want to work on lowering your debts
- Above 43% often triggers concern. Paying down debt or raising your income should be a priority before you apply for major loans like a mortgage.
Tips to lower your DTI
To lower your debt-to-income ratio, start by paying more than the minimum on your credit cards whenever possible. This helps reduce your balances faster and lowers your minimum required payments over time, which can significantly impact your DTI.
You might also consider consolidating debt with a lower-interest personal loan or a balance transfer credit card. Just be sure you have a clear plan to pay it down quickly before any promotional rates expire. While working to improve your DTI, it’s wise to avoid taking on any new debt.
Finally, increasing your income, whether by negotiating a raise, picking up a side hustle, or finding another reliable income stream, can also help shift your DTI in the right direction.
Bottom line
Credit card debt might feel manageable in the short term, but because it’s revolving debt with high interest rates, it can significantly raise your debt-to-income ratio and limit your financial flexibility.
Since credit card balances are factored into your DTI using minimum payments, it’s wise to prioritize paying down credit card debt early especially if you have several cards. Committing to keeping your balances low or better yet, paying your cards off in full each month not only helps maintain a healthier DTI but also saves you money on interest.
If your DTI is creeping higher than you’d like, start by reviewing your credit card usage, trimming unnecessary expenses, and focusing on paying off high-interest balances first.
