Debt-to-income ratio, or DTI, is a metric used by lenders to assess your financial situation before approving you for certain types of loans. This, along with your credit score, is something you’ll want to regularly keep tabs on to help measure your financial wellness.
Unlike other financial terminology and formulas, DTIs are easy to understand and track on your own.
Let's go over what you should know about your debt-to-income ratio. You'll learn what DTI means, the easiest way to calculate it, and how lenders factor it into their decision-making process.
What Does Debt-to-Income Ratio Mean?
Your DTI ratio is the amount of money you pay each month compared with how much money you earn each month.
It's calculated using your gross income, which is your income before taxes and other deductions.
Your mandatory expenses also get included in this calculation like rent, utility bills, credit card payments, and more (see below). If you receive a bill in the mail, that’s a sign it’s considered a mandatory payment.
Why It's Important
Your DTI ratio is important because it tells lenders about your financial habits and wellness and whether you know how to manage your money.
The lower debt you have when compared to your income, the less risk you are for taking on a new payment. On the other hand, if you have a high DTI ratio, lenders might question your ability to make payments in full or on-time. Research from existing mortgage loans suggests that when a borrower has a high DTI, they’re more likely to have trouble keeping up with monthly payments, according to the Consumer Finance Protection Bureau.
What’s a Good Debt-to-Income Ratio?
It’s ideal to keep your DTI ratio below or around 35%. That is what lenders view as manageable debt. If your DTI ratio is a tad higher, you still have opportunities to borrow money and finance large purchases. The goal should always be to have as little debt as possible.
If you see yourself inching towards a DTI ratio that exceeds 40%, that’s a sign you should start looking for ways to improve that ratio.
Many mortgage lenders require less than a 43% debt-to-income ratio, and other lenders may approve someone with one as high as 49%. This doesn’t mean it’s impossible to get a loan, credit card, or mortgage, but you might be less likely to get approved for one.
Monthly Payments that Factor Into DTI Ratios
- Credit cards
- Car loans
- Student loans
- Personal loans
- Real estate taxes
- Homeowners insurance
- Child support
- Co-signed loans
Monthly Payments that Do NOT Factor Into DTI Ratios
- Utilities: water, garbage, electricity, gas
- Cell phones
- Car insurance
- Health insurance
How to Calculate Your DTI Ratio
Calculating your DTI ratio is not as complicated as other financial equations. It’s a little bit of addition and some division. You won’t even need one of those fancy calculators from high school math class!
Here are two ways to calculate your debt-to-income ratio.
1. Use an online calculator
While calculating your DTI is quite simple, there are calculators available online that will calculate it for you. I’ve found that calculating my own takes the same amount of time or less, and helps me better understand what’s factored in the formula.
2. Calculate it on Your Own
As mentioned, the benefit to calculating your own DTI ratio is it helps you better understand where you stand financially and have an idea of what your DTI ratio could be if your monthly expenses change.
First, you’ll add together all of your monthly expenses, then divide that amount by your gross monthly income. If you are paid bi-weekly, divide your annual salary by 12. It’s that easy!
Minimum Payments. When adding together your monthly expenses, you only need to add together minimum payments. If you’re paying more each month, great job. Keep in mind when calculating your DTI ratio that it could skew your result when you’re actually doing well.
Let’s say that your gross income is $4,000 each month. Your mandatory expenses include rent ($800), a car payment ($300), a student loan payment ($150), and a credit card payment ($50).
Step 1: Add up monthly expenses. For this example, that would be $800 + $300 + $150 + $50 = $1,300
Step 2: Divide it with your gross monthly income. For this example, that would be $1,300 / $4,000 = 32.5
In this situation, your DTI ratio is 32.5%.
Debt-to-Income Ratio Ranges
Now that you understand how to calculate your DTI ratio, it’s time to dive deeper into what it means about your financial wellness. It’s good to know when you’re in the clear, can work to improve your DTI ratio, and when you need to take action.
Up to 35%: Looking Good
If your DTI ratio is 35% or lower, give yourself a high five! That’s great. You’re likely able to pay all your monthly bills with ease and are putting a decent amount into a high-yield savings account. Lenders view this range as favorable and low-risk.
Between 36% and 49%: Room to Improve
This range tells lenders that you’re doing a decent job at managing your debt but could be doing a better job. Lenders may vary in whether your DTI ratio is seen as favorable, so be sure to shop around for the best rates.
Higher than 50%: Time to Take Action
If you’re not already taking steps to improve your DTI ratio, now's a good time to start. This means half or more of your income is going toward paying bills; leaving you will minimal disposable income. Instead of borrowing more money, it’s time to figure out how to pay off some of your existing debts.
What Personal Loans Can I Get If I Have a High DTI Ratio?
When your DTI ratio is on the higher end of the scale, you could have some trouble qualifying for a personal loan. But it’s not impossible. There are specialty lenders that work with individuals with a less than ideal DTI ratio. If you’re able to get a co-signer to apply for a joint loan, your chances of getting the loan amount you desire increases even if your personal DTI ratio is high.
How Does My DTI Ratio Impact Home Equity Loans?
Your DTI ratio can impact your ability to get a home equity loan. If you want a fixed term and rate for your home equity loan, the federal government has set a DTI ratio cap at 43%.
For other types of home equity loans, it's possible to get one with a DTI ratio as high as 50%, but you’ll be in a better position if you’re able to pay off other debts before applying for the loan.
How Does My DTI Ratio Impact VA Loans?
The Department of Veteran Affairs determines the amount you’re allowed to borrow based on your family size, where you’re buying a home, and how much residual income you have each month. Because of these standards for VA loans, your DTI ratio might not impact your borrowing power as much if you meet the other requirements.
How Does My DTI Ratio Impact Car Loans?
Like with any loan, car loans can also be impacted by your DTI ratio. If your DTI ratio is 50% or higher, be prepared to get a quick no when you ask about financing options. This is because your high DTI ratio signals to the lender that they may need to repossess your car in the future — a situation both parties want to avoid.