If you applied for a credit card but were denied despite having good credit, the reason is most likely you have a high debt-to-income ratio (DTI). This all-important ratio may not directly affect your credit score, but it does play a key factor in whether you receive a credit card when you apply.
As its name suggests, your DTI represents the difference between the amount of debt you owe and your income. This ratio shows how much you spend each month on debt compared to your monthly income. It’s expressed as a percentage. A debt-to-income ratio of less than 30% to 36% is generally considered a low (good) DTI. If it’s more than 40%, lenders consider you a high-risk borrower, no matter how good of a credit score you have.
When it comes to getting a credit card, DTI is just as important as your credit score, if not more so. Think of your DTI as a piece of pie. If most of your financial pie is made up of debt, there’s not much left over to feed any new debt. For that reason, credit card issuers will opt to turn down your application. They will see your pie as too full of debt.
How to calculate your debt-to-income ratio
To calculate your DTI ratio, add up all of your monthly debts (see the list below) and divide this total by your monthly, pre-tax (gross) income. This number is your DTI ratio.
For example: Let’s say you make $5,000 per month gross pay and your monthly expenditures are $1,900. Divide $1,900 by $5,000 and you get 38%, which equals your DTI. This sample ratio is likely to be too high to allow for approval for a new credit card. If you want to double check the accuracy of your calculations, try using an online DTI calculator.
In determining your DTI, it’s important to include all of your debt. The following debts need to be factored into your monthly costs:
- Mortgage or rent payment
- Car payments
- Student loan payments
- Personal loans
- Minimum credit card payments due and their balances
- Any court ordered child support or alimony payments
- Insurance, taxes and association dues associated with owned property
What happens when you have a high DTI ratio
A high DTI ratio of 37% or more indicates to the credit card company that debt consumes too much of your income. They theorize that if they were to give you a new credit card and something happened to strain your budget, such as a financial emergency, you might not be able to cover all of your financial obligations. Your DTI represents too high of a risk for them to gamble on you paying a new debt as required.
If your DTI is high, rather than turn you down for a credit card, the credit card company may offer you a card with a high interest rate. A low DTI, on the other hand, helps you get a credit card with attractive interest rates, such as the Citi Double Cash Reward Card, which offers a low APR for borrowers with a low DTI and gives you 1% cash back on purchases and 1% cash back on your payments.
In addition to credit cards, lenders look closely at your DTI before giving you a mortgage. The rule of thumb is that you should have a DTI that is 36% or lower. According to the Consumer Financial Protection Bureau, a 43% debt-to-income ratio is usually the highest DTI you could have to qualify for a mortgage. It is rare, though, that you would qualify with a DTI that high. So if you’re planning on applying for a mortgage, a low DTI is critical.
Many mortgage lenders use the 28/36 rule-of-thumb for determining how much debt a borrower can take on. This says that you should spend a maximum of 28% of your gross monthly income on housing and no more than 36% of your income on total debt, including housing.
The ideal DTI for credit cards is 36% or lower. To determine what you want to aim for in terms of debt, multiply your monthly gross income by 36%.
$3,000 gross per month x 36% recommended maximum DTI = $1,080 (maximum amount of your monthly debt payments)
How to lower your DTI
It’s possible to lower your DTI so that you qualify for attractive credit card offers. Two avenues exist for doing this. You can increase your income and/or lower your debt. Doing each simultaneously often results in the fastest route to a good debt-to-income ratio.
Increase your income
Ask for a raise or offer to work overtime at your job. If that isn’t an option, consider taking on a part-time job or making money on the side. In today’s gig economy, there are a variety of ways to make some extra cash. You can use your skills, including tutoring, child care, dog walking or housesitting, life coaching or even selling handmade items. Many people find starting a side business to be fun, and the extra income is a definite bonus.
Pay off your debt
Paying down your bills, including credit card balances and personal and auto loans, goes a long way toward reducing your DTI. When lenders see less owed, they consider this a good sign that you’re ready and able to handle an increased debt load in the form of a credit card.
Of course, getting out of debt is a long and slow process that takes reducing your expenses and setting up a workable budget. The fact is that living below your means and only buying what you need and can afford is the key to financial freedom. When you live this way, you have a low debt-to-income ratio that allows you to qualify for appealing credit card offers, such as those that offer a 0% introductory rate for a period of six to 18 months and generous cash back and airline mileage benefits.
It’s also important when you’re working toward a lower debt-to-income ratio that you stop charging on credit cards. Each time you do so, you make your DTI ratio higher. Not charging excessively on your cards shows the credit card company that you use credit responsibly.
As you work toward lowering your DTI, check back regularly to see that you’re making progress by recalculating. Doing this will help ensure you’re moving in the right direction. Seeing your DTI percentage go down will probably inspire you to keep cutting costs and raising your income.
Consider the fact that you were denied a credit card because of a high debt-to-income ratio as a benefit. Finding out that your debt has risen to a point that is considered dangerously high can give you the motivation you need to get your financial house in order.
When you’re ready to apply for another card, check out SuperMoney’s Best Personal Credit Cards Reviews & Comparison.
Julie Bawden-Davis is a widely published journalist specializing in personal finance and small business. She has written 10 books and more than 2,500 articles for a wide variety of national and international publications, including Parade.com, where she has a weekly column. In addition to contributing to SuperMoney, her work has appeared in publications such as American Express OPEN Forum, The Hartford and Forbes.