Debt-To-Income Ratio: Calculator And Explanation
Debt-to-income ratio (DTI) refers to the percentage of a person’s monthly income that goes toward paying down debt. You may start struggling to secure loans or to get advantageous loan terms if your DTI is above 36%. A DTI ratio of about 43% will almost certainly impede your ability to get a new loan.
While there’s more to your financial situation than your DTI, it isn’t just a tool for lenders and banks to determine whether you are 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.
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 the following when calculating your DTI ratio.
- Minimum credit card payments
- Student debt payments
- Mortgage payments
- Car loans
- Personal loans
- Any other miscellaneous debts that you may carry
What Is My Debt-To-Income Ratio? Learn How To Calculate Your DTI
Calculating your debt-to-income ratio is quite simple. All that it requires is adding up your total monthly debt payments and then dividing that number by your gross monthly income - the income you make before taxes or other deductions come into play.
Couples And Debt-To-Income Ratio Calculations
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 are considering 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.
Some Debt-To-Income Ratio Calculation Examples
Alex 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 will add together these debts, resulting in a total of $3,000, then divide that number by $6,000.
We end up dividing 3,000 by 6,000.
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.
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.
When we divide 1,000 by 5,000, we get a DTI ratio of 20%.
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 our previous calculation.
What’s Considered A Good DTI?
We’ve already talked about the highest DTI ratio you can have and still secure a loan on good terms. But what is a good DTI ratio? Most experts agree that a DTI ratio of 18% or lower is excellent. However, many people live comfortably with a much higher DTI ratio than this.
How Can Knowing My DTI Ratio Help Me?
One of the best uses of the DTI for an individual is as a way of avoiding decisions that will create too much of a pinch. One common situation that a good understanding of DTI calculations can help you to avoid is becoming “house poor.” Being "house poor" means that you are paying an uncomfortably high percentage of your income into your mortgage. Knowing your DTI ratio can also be great motivation to begin paying off debt to lower your DTI.
Of course, there are certainly exceptions to every rule. Some people are willing to make sacrifices to live in a location they either love or need to live in to sustain a location-limited career.
Does A High DTI Ratio Mean I’m Doing Poorly Financially?
A high DTI ratio doesn’t necessarily mean you need to lose sleep at night. To return to our earlier example of Alex and Jordan, even without Jordan’s income, Alex still has $3,000 to spend each month after taking care of debt. For many lifestyles, that could be perfectly comfortable, and even relatively low-risk – particularly if Alex has a solid emergency fund built up to provide a cushion in the case of a job loss, a health crisis or any other unforeseen life change (including divorcing Jordan).
It’s also worth keeping in mind that alimony payments are often able to be re-negotiated in the case of a major change in finances, and student loans can sometimes be deferred. A DTI ratio of 57% is not a number that will convince lenders that someone should be taking on further debt, but you should take a measured approach to using a DTI ratio to assess your financial health.
Does Your DTI Affect Your Credit Score?
Although both your DTI ratio and your 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.
While there’s more to your financial situation 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. You should 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 that there is more room in your budget for a new loan than you had previously thought. And if you’re interested in learning more about our process and whether you are ready for a loan, you check out your personal loan offers today without it impacting your credit score.
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