What Is Debt-to-Income Ratio (DTI)? (And How To Calculate It)

Whether you’re gearing up to buy a new car or looking for that perfect starter home, your debt-to-income ratio (DTI) will have an impact on what you can purchase and when you can purchase it.

In the case of making large purchases that require financing, your DTI is important because banks will use it to gauge whether or not they want to loan to you.

Luckily, you can calculate your DTI on your own, which will allow you to predict which loans you could be approved for. After all, the more you know about your financial situation, the easier it will be to make decisions about your income that will further your goals.

Key Takeaways:

• The debt-to-Income ratio, or DTI, is the ratio of monthly debt divided by monthly income.

• A good DTI is considered 43% or lower.

• A poor DTI can make it harder to receive loans which will affect your long term financial goals.

What Is Debt-to-Income Ratio?

Your DTI ratio is represented as a percentage to show the portion of your average income spent on debts. For example, if your DTI ratio was 23%, that number would indicate that you dedicate 23% of your gross income to debt payments each month.

Ideally, you’ll want your DTI ratio to be as low as possible. After all, a high DTI of 60% would leave you little income to spend on groceries, events, or hobbies. In fact, a high DTI ratio is a huge red flag for investors and lenders, as the percentage will suggest that a borrower cannot handle taking on any more loans.

As a result, it’s no surprise that the debt-to-income ratio will usually affect what borrowers can finance as banks and other lenders will analyze it before deciding to lend money.

How Banks Assess Debt-to-Income Ratio

Typically, banks and other lenders will want your debts to account for no higher than 36% of your monthly income. While there can be leeway of up to 5%, the lower the DTI, the better. Banks stick to these numbers to ensure that borrowers will have enough income remaining to handle the extra expense of a new loan.

Banks also value a low DTI because it’s an important piece of your financial puzzle. For instance, a high DTI might correlate with a low credit score caused by late payments.

However, not all lenders are the same. For example, if you were looking to buy a house, an unconventional loan such as an FHA loan may accept a higher DTI ratio. Often, unconventional loans may come with additional expenses or restrictions but are still options nonetheless.

The Debts Included in Your DTI Ratio

Knowing what kind of debts are included in a DTI ratio can help you understand how a bank will calculate your DTI ratio, as well as allow you to calculate your own. Some of the most common recurring debts include:

• Rent or Mortgages

• Auto Loans

• Student Loans

• Child Support Payments

• Alimony Payments

• Minimum Credit Card Payments

• Personal Loans

Generally speaking, your DTI ratio does not include utility bills or necessities such as food and gas.

Therefore, if you’re looking to acquire a new loan, it’s important that you not only analyze your DTI but also account for any extra expenses you have each month. Even if lenders won’t inspect these extra costs, it’s certainly in your best interest to know exactly what you can afford.

How To Calculate Your DTI Ratio

For the most part, calculating your DTI ratio is actually rather simple. First, gather information using the following steps:

1. Add up your monthly debt payments to determine your total monthly debt.

2. Determine your total monthly income before taxes.

3. Divide your total monthly debt payment by your gross monthly income.

4. If your income is higher than your debt, you will yield a decimal

5. Multiply the decimal by 100 to discover your DTI percentage.

The DTI equation is:

If you find that your debt-to-income ratio ​is above 50%, you might need to pay off some of your previous loans before you can consider a new purchase. While on the other hand, if your DTI ratio is below 30%, you may find that you can be approved for a larger loan than you expected.

Either way, always be aware of your most up-to-date DTI status, as the information will allow you to make more thoughtful financial decisions.

Debt-to-Income Ratio Example

To picture the importance of DTI in a realistic context, imagine the following scenario:

Example DTI

Tips for Improving Your DTI

Overall, there are two ways in which you can effectively lower your debt-to-income ratio:

• Lower your debt. To lower your debt you’ll need to prioritize your expenses and make sacrifices when necessary. You may need to consider lowering other expenses so that you can pay off your debt.

• Increase your income. Likely to raise your income you’ll need to either get a raise from your current job, get a new, higher paying job, or taking on a second job. These are not easy choices and require effort and determination. Consider learning new skills to make yourself a candidate for better paying positions.

While it’s understandable that these measures aren’t always easy, taking incremental steps toward decreasing your DTI can be extremely beneficial in the long run. When in doubt, look over your options and do whatever you can to work toward your financial goals.

Understanding Your Financial Goals

Your DTI ratio is a valuable financial measurement that can help shine some light on your current financial situation. After all, we can’t expect to make tangible financial goals if we don’t have a grasp on where we currently stand.

Think about where you see yourself in a year, or even five years. Do you want to own a house? Or trade in your used car for a new one? If you have a specific financial goal in mind, it’s important to make plans that will help you achieve that goal.

In other situations, knowing your financial goals can also allow you to make intelligent investments, as well as avoid falling victim to the most negative side effects of interest or inflation.

Ultimately, no matter what your current circumstances may be, it’s never too late to start looking into aspects of your financial situation, such as your DTI ratio, in order to plan for the future.

Debt-to-Income Ratio FAQs

1. What is Debt-to-Income Ratio?

The debt-to-Income ratio, or DTI, is the monthly amount of debt a person or organization owns divided by their income. This is usually multiplied by 100 and represented as a percentage. DTI is use by lenders to decide if and how they will loan out money because it reveals financial health and stability.

2. What’s a good debt-to-income ratio?

Anything 43% or lower is considered a good DTI. In some unique cases a higher DTI may be acceptable. For example if the length of the loan is low risk or the credit of the person/organization is in good condition.

3. How do I find out my DTI?

To calculate your DTI, divide your monthly debts by your income. You will need to know your monthly debts. These can be mortgages, student loans, car loans, and child support payments. Generally, bills such as utilities are not included.

References

1. Consumer Protection Financial Bureau – What is a debt-to-income ratio?

Author

Jack Flynn

Jack Flynn is a writer for Zippia. In his professional career he’s written over 100 research papers, articles and blog posts. Some of his most popular published works include his writing about economic terms and research into job classifications. Jack received his BS from Hampshire College.