A Guide To Debt-To-Income Ratio: How To Calculate It And Why It Matters
Miranda Crace5-Minute Read
UPDATED: July 26, 2023
Before you apply for a loan, it’s best to have a firm understanding of your current debt situation. Lenders will use your debt-to-income (DTI) ratio as a way to assess your ability to repay the money that they’re considering lending to you.
However, DTI isn’t just a tool for lenders and banks to determine whether you’re eligible for a mortgage or personal loan. Calculating your DTI for yourself can also help you decide whether you want to take on more debt.
In this guide, we’ll provide you with an overview of DTI and explain how to calculate debt-to-income ratio.
What Is Debt-To-Income Ratio?
Debt-to-income ratio is the percentage of gross monthly income that a person pays toward their monthly debts. Lenders use this ratio to calculate the risk associated with lending you money.
What Is A Good DTI Ratio?
Your DTI ratio should be lower than 36%, and less than 28% of that debt should go toward your mortgage or monthly rent payments. You may find yourself struggling to secure loans or advantageous loan terms if your DTI is above 36%, and a DTI ratio of around 43% will almost certainly impede your ability to get a new loan.
What Is Included In The Debt-To-Income Ratio?
The debts that are included in this calculation may surprise you. For instance, monthly rent payments are often counted as debt for this calculation, and so is alimony. For the purposes of a DTI ratio calculation, debt doesn’t have to come from a loan.
If you’re considering a loan of any kind, whether it’s a personal loan or a mortgage loan, you’ll want to have your DTI ratio calculated. You should factor in these debt payments when calculating your DTI ratio.
- Minimum credit card payments
- Student loan payments
- Child support payments
- Mortgage payments
- Auto loans
- Personal loans
- Any other miscellaneous debts that you may carry
How Is Debt-To-Income Ratio Calculated?
Calculating your debt-to-income ratio is quite simple. To determine your DTI ratio:
- Add up all of your monthly debt payments (which don’t include utilities, groceries, phone and cable bills, insurance costs, etc.).
- Divide your total debts by your gross monthly income (the amount you make before taxes or other deductions come into play).
- Your DTI is the percentage that you get from this equation.
Let’s take a look at a few examples of DTI calculations.
In our first example, we have Alex, who makes $6,000 per month – a salary that is far above the U.S. average. However, Alex’s debts for the purpose of a DTI ratio calculation are as follows:
- An alimony payment of $1,500 per month
- A car payment of $500 per month
- A rent payment of $1,000 per month
Alex: $3,000 (total debts) ➗ $6,000 (income) = 50% DTI
Alex’s DTI ratio is high, at 50%. With this ratio, we can determine that Alex will likely struggle to secure a personal loan or mortgage, despite a high salary.
Next, let’s compare Alex to Jordan, whose income is lower but whose debt is also lower. Jordan makes $5,000 per month. Jordan’s car and student loan debts have both been paid off. The only debt for the purpose of this calculation is a rent payment of $1,000 per month.
Jordan: $1,000 (total debts) ➗ $5,000 (income) = 20% DTI
Calculating Your DTI Ratio As A Couple
When buying a home, a mortgage is often shared by a couple, which means that the DTI gets calculated for the couple, rather than for the individual. Some lenders also offer personal loans to couples and may even loan larger amounts in these cases.
If you’re thinking of getting a personal loan as a couple, you should determine your DTI ratio as an individual and as a couple and compare the results. If one partner has more debt than the other, it’s an especially good idea to calculate whether a shared loan will put you ahead or behind.
What happens if Alex marries Jordan? For the purposes of a shared mortgage, or for a couple’s personal loan, their combined DTI ratio would be calculated by dividing 4,000 by 11,000 (assuming their total rent is $2,000, not $1,000), resulting in a DTI ratio of 36%. As a couple, they would still likely be approved for nearly any loan, despite Alex’s high DTI ratio in the previous calculation.
How To Lower Your Debt-To-Income Ratio
Lowering your debt-to-income ratio can help increase your odds of approval when applying for a new loan. When simply increasing your income or decreasing your debt isn’t such a simple solution, these strategies can help you reduce your DTI ratio.
- Pay down your debt. Making more than the minimum payment on your debts each month can help you lower your debt faster.
- Track your spending. Creating a monthly budget that you can stick to will help you identify expenses that can be cut, and you may be able to reduce your spending. You can then use this extra money to lower your debt.
- Avoid additional debt. Not taking on new debt or making any large purchases on your credit cards is wise, especially if you plan on buying a home or applying for a personal loan in the near future. Taking on new expenses before you apply for a mortgage can increase your DTI ratio and potentially hurt your credit score.
- Consider using a debt consolidation loan. If you aren’t financially able to make additional payments toward your monthly debt, you may want to consider a debt consolidation loan. This loan can help you pay down your debts over time with a consolidated payment and, ideally, a reduced interest rate.
Debt-To-Income Ratio FAQs
Below are answers to a few questions you may have when calculating your DTI ratio.
Does debt-to-income ratio affect credit score?
Although both your DTI ratio and credit score will affect your ability to get a loan, one piece of good news is that your DTI will have no effect on your credit score itself. Your credit score is all about your credit history.
How can knowing my DTI ratio help me?
Knowing your DTI ratio is helpful for avoiding decisions that will create too much of a pinch on your budget, such as falling into a state of “house poor,” which means you’re spending an uncomfortably high percentage of your income on your mortgage. Knowing your DTI ratio can also be great motivation to begin paying off debt to lower your DTI or assessing your odds of being approved for a loan.
What is the difference between debt-to-income ratio and credit utilization rate?
Although these two calculations may sound similar, they are different. A credit utilization rate (or debt-to-credit ratio) evaluates how much of your credit you’re using (that is, your credit card balance) in comparison to your credit limit. Your DTI evaluates your monthly debt expenses compared to your monthly income.
While there’s more to your personal finances than your DTI ratio, your DTI isn’t just an arbitrary number that lenders use to make life difficult. Understanding the relationship between your debt and your income can help you decide whether you feel ready to take on a new personal loan. It’s best to weigh all aspects of your financial security and consider your priorities carefully, taking your DTI ratio as a starting point.
By using your DTI ratio as a guide, you may actually find more room in your budget for a new loan than you had previously thought. If you’re interested in learning more about our process and whether you’re ready for a loan, check out your personal loan offers today without impacting your credit score.
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