The debt-to-income ratio (DTI) is a metric lenders use that compares your total monthly debt payments to your gross monthly income.
It measures your ability to manage your existing debt obligations compared to your income.
It is also usually a critical factor in determining whether you can borrow more money.
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Calculating your debt-to-income ratio is easy
You may not enjoy math, but you’ll need to do some quick calculations if you want to apply for a loan or new credit card.
Follow this formula: DTI ratio = (Total monthly debt payments / Gross monthly income) x 100
Here’s a step-by-step breakdown of how to calculate the DTI ratio
Add up your total monthly debt payments
This includes all current debt obligations, including:
- Mortgage payments
- Rent payments
- Credit card debt payments
- Student loan payments
- Payday loans
- Title loans
- Auto loan payments
- Personal loans
- Lines of credit
- Child support
- Alimony
- Any other recurring debt payments
Use your monthly payment if you have fixed-rate loans (like personal loans). Use the monthly minimum payment for variable-rate loans (like credit card payments or home equity lines of credit).
Here is an example
Add up the amount of debt you have:
- Monthly mortgage payment: $1,500
- Car payment: $500
- Minimum credit card payments: $225
- Home equity line of credit payment: $200
Monthly debt obligations: $2,425 (this is also called the back-end ratio)
Pro tip: Your home loan payment will be your regular monthly payment if your property taxes and homeowner’s insurance are held in escrow. If you pay taxes and insurance separately, lenders will add up your annual tax and insurance payments, divide them by 12 and include that as part of your monthly mortgage obligation.
Calculate the gross monthly income
This refers to your total income before any deductions or taxes are removed. You can include all steady sources of income, including
- Salary
- Wages
- Bonuses
- Commissions
Here’s an example
- Monthly gross income: $6,000
- Monthly gross income from a side hustle: $750
Total monthly gross income: $6,750 (also known as the front-end ratio)
Divide the total monthly debt payments by the gross monthly income
- $2,425 divided by $6,750 = .359
- Multiply the result by 100 to calculate the percentage
- .359 x 100 = 35.9
In this example, your DTI is 35.9%. This should be acceptable for most lenders.
Pro tip: If this is too much math, you can use a DTI calculator.
To learn about why your DTI ratio is important, check out this video:
What is considered a good debt-to-income ratio?
The debt-to-income ratio is not technically a part of your credit history. However, it will be used to determine whether you’re eligible for new credit.
Each lender uses different standards, but a DTI of 43% is the most common benchmark.
A DTI higher than 43% indicates that you could be a risk and will make qualifying for a new loan tougher.
Pro tip: If you’re starting the home buying process, a DTI of 43% is usually the maximum mortgage lenders will consider for eligibility.
DTI ranges
- Low DTI ratio: A DTI below 35% is ideal. It shows that you’ve responsibly managed your debt and repay it on time. You won’t immediately start defaulting on payments if you face a sudden hardship.
- Room for improvement: If your DTI is between 36% to 49% (like the example above), it implies you don’t have a lot left over to cover your other monthly bills. It’s worth improving your number before applying for a major loan. Otherwise, you may pay a higher interest rate.
- High DTI ratio: A DTI above 50% is a concern. It shows lenders that you’ve taken on more debt than you can realistically afford, and it’s unlikely that most lenders will be willing to give you a new loan.
READ MORE: Types of debt to consolidate
How to lower your DTI ratio
- Pay more toward your existing debts each month: Use a strategy like debt snowball and pay more than the minimum payments each month. This can quickly lower your DTI.
- Don’t take on more debt: Before applying for new credit or a new loan, reduce your total existing debt.
- Consolidate your existing debts: Debt consolidation rolls your other smaller loans into one larger loan with a longer loan term and lower monthly payment. The lower monthly payment will improve your DTI ratio. You can even consolidate payday loans.
- Delay major purchases: Reduce your DTI ratio before buying big-ticket items. Not only will those purchases further increase your DTI numbers, but the loan will also cost you more in interest.
- Know your numbers: Monitor your DTI ratio. Seeing the number fall can be a powerful motivator that encourages you to pay off more of your debt as you see your numbers improve.
READ MORE: What is debt consolidation?
Three ways to reduce your debt-to-income ratio
The bottom line
The DTI ratio is a key indicator of financial health. Though it isn’t a direct component of your credit score, a high DTI ratio could be a warning sign to lenders, who may fear that you’d have trouble repaying a loan. This could indirectly cause your credit score to suffer. If your ratio is in the danger zone, take some steps to improve it before you need a new loan.
FAQs
The Federal Housing Administration issues home loans to eligible borrowers that have less stringent credit score and DTI requirements than conventional mortgage lenders. A 43% DTI is standard for an FHA mortgage, but ratios up to 56.9% are accepted for borrowers with compensating factors.
The DTI ratio won’t directly impact your credit score. However, it could directly impact whether a lender is willing to let you take on new debt. If your debt-to-income ratio exceeds the lender’s threshold, your loan application could be denied or you could be charged higher interest rates.
While both ratios are important, they serve different purposes. The DTI ratio reflects your total debt payments in relation to your income, offering lenders insight into a borrower’s ability to handle debt payments. A credit utilization ratio is focused specifically on credit card usage and can impact your credit score. It compares your total credit card debt in relation to your total credit limit. For example, if you have $15,000 in available credit across three credit cards, and you have $1,000 in debt on each card, your credit utilization ratio would be 20%.
