Debt-to-Income Ratio: How to Calculate Your DTI
Published February 26, 2024 at 9:16 am
A debt-to-income ratio, also referred to as a DTI, is a concept you may not think about much, but lenders do. If you’re going to apply for a loan in the near future, it wouldn’t be a bad idea to become acquainted with the phrase debt-to-income ratio as well as other related terms and tools, like a debt-to-income ratio calculator and debt ratio formula.
The more you understand about how to calculate a debt-to-income ratio, the better off your finances will be. And the lower your DTI, the better your loan terms will ultimately be—that is, of course, if you use the information you collect to improve your financial situation.
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Vault’s Viewpoint on DTI Ratios
- A debt-to-income ratio is a simple math equation in which your monthly debt payments are divided by your gross monthly income.
- Many lenders, especially mortgage lenders, look at a consumer’s debt-to-income ratio before issuing a loan. It’s a useful way of determining whether a borrower will be able to make payments.
- A debt-to-income ratio is a good thing for any consumer to know, even if you aren’t looking for a loan.
What Is a Debt-to-Income Ratio?
Simply put, your debt-to-income ratio is the percentage of your monthly income that goes toward your debt. So, if you spend 30% of your monthly income toward your house, car, credit cards and student loans, your DTI ratio would be 30%.
Why does understanding a DTI matter? Well, it matters to a lender. Credit scores get most of the attention from lenders and consumers, but you could have a good credit score and be turned down for a loan because your DTI is too high.
For instance, many mortgage lenders prefer to see a potential borrower with a DTI ratio that, once the housing payment is factored in, will be less than 36% (although some will go up to 43%). If you’re looking to buy a house, your DTI will suddenly become very important to you.
Even if you aren’t in the market for a loan, it can be helpful to know your DTI ratio. Doing so can help you better understand your overall financial health outside of your credit score.
How to Calculate Debt to Income Ratio
You can use a debt-to-income ratio calculator to figure out your DTI ratio, but it isn’t hard to do on your own.
First, add up your monthly debt payments. Let’s say that you spend $1,800 a month on various debts. Then, take your gross monthly income (let’s say it’s $7,000 a month), which is the money you earn before you take out taxes or any deductions. Next, divide your total monthly debt payments by your gross monthly income.
In this example, your debt formula would look like this: $1,800 ÷ $7,000 = 25%.
A 25% DTI isn’t too bad. Assuming you’re looking for a mortgage loan and have a good credit score, you’d probably get your house in this scenario.
What Debts Should Be Counted in a Debt-to-Income Ratio?
In case you’d like some examples of what types of debts should be included when figuring out your DTI, here’s what lenders tend to include when calculating it:
- Monthly mortgage payments, including homeowners’ insurance and real estate taxes
- Rent payments (if you’re moving into an apartment, the management company will include rent in your debt-to-income ratio)
- Monthly car payments
- Monthly student loan payments
- Minimum monthly credit card payments
- Monthly timeshare payments
- Monthly personal loan payments
- Monthly child support payments
- Monthly alimony payment
- Any loan monthly payments you’ve co-signed for (a lender will likely include it as part of your DTI, but if you’re calculating for your own benefit, you may want to leave this off)
Payments you won’t want to include as part of your DTI:
- Monthly utilities, such as your electric bill
- Car insurance payments
- Life insurance payments
- Cable or internet or cellphone bills
- Healthcare costs, such as health insurance payments
- Groceries and gas
Leaving out certain monthly payments when calculating a debt ratio formula can seem a little odd, given how important they are in your budget. These monthly expenses, though, aren’t considered debt (as long as that utility bill hasn’t somehow gone to a debt collection agency).
How to Understand Your Debt-to-Income Ratio
Once you calculate your debt-to-income ratio, the percentage can indicate the following:
Debt-to-Income Ratio of 36% or Less
If you have a DTI ratio of 36% or less, a lender is probably going to be pretty happy with that. It’s rare to have a DTI of 0%, and while that may be your goal, it’s not a requirement. Lenders expect that you’re carrying some sort of debt, whether that be a car payment or student loans—they just don’t want to see your debt-to-income ratio reaching unmanageable levels.
Debt-to-Income Ratio of 36% to 41%
If your DTI is in this range, a lender may feel that your monthly debt numbers are reasonable. This is a range in which you may start to have trouble getting large loans.
Debt-to-Income Ratio of 42% to 49%
If your DTI is between 42% and 49%, don’t be surprised if a lender rejects your loan application. A lender may be unwilling to service you if almost half of your income is going toward debt. That said, you still may be able to find financial institutions willing to lend you money.
Debt-to-Income Ratio of 50% or More
If your DTI is 50% or more, it’s anybody’s guess as to whether you’ll get a loan approved. You’ll have a better chance if you regularly make payments on time and your credit history is spotless. But this is the point where most lenders are going to be nervous about lending you any more money until you can pare down your debts.
If you think about it, lenders have reason to be wary. If your DTI is over 50%, over 50 cents of every dollar you earn is going toward something you’ve already purchased, leaving very little money left over for things you’re buying now or will buy in the future. That is, you may not have much money left over to put toward retirement savings such as a 401(k) or an emergency fund.
Frequently Asked Questions
What Is a Good Debt-to-Income Ratio?
A general rule of thumb is that the lower your debt-to-income ratio, the better. Lenders like to see borrowers with a DTI ratio of no more than 36%. If you have a debt-to-income ratio of 35% or less, you can consider yourself in good shape.
Does Your Debt-to-Income Ratio Affect Your Credit Score?
You would think so, but technically, no. Your DTI isn’t a factor that affects your credit score. That said, lenders do often consider your DTI, along with your credit score, when deciding whether to approve a loan. So while your debt-to-income ratio won’t affect your credit score, it could affect your chances of getting a loan.
What Happens if My Debt-to-Income Ratio Is Too High?
If you try to apply for a loan with a high DTI ratio, a lender may turn you down if it thinks you’d have trouble adding another debt payment to your budget. Even without applying for loans, if your debt-to-income is too high, it may indicate that you’re struggling with paying bills on time and making ends meet.
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