The debt-to-income ratio calculation shows how much of your debt payments consume your monthly income. This information helps both you and lenders figure out how easy it is for you to afford monthly expenses. Along with your credit scores, your debt-to-income ratio is an important factor for getting approved for a loan.
A debt-to-income ratio, also known as a DTI ratio, is quoted as a percentage. For example, you might have a debt-to-income ratio of 25%, meaning one-quarter of your monthly income goes toward debt repayment. If your income is $4,000 per month, 25% of that would be $1,000 of total monthly debt payments.
How Do You Calculate Debt-to-Income Ratio?
To calculate your current debt-to-income ratio, add all of your monthly debt payments, then divide your monthly debt payments by your monthly gross income.
Note
Multiply your income by a target debt-to-income level, such as 30%. The resulting dollar amount is an upper limit on your total monthly payments if you want to meet that target.
Monthly debt payments include the required minimum payments for all your loans, including:
Auto loans
Credit card debt
Student loans
Home loans
Personal loans
The gross monthly income used in the calculation equals your monthly pay before any deductions for taxes or other items on your paycheck.
How Your Debt-to-Income Ratio Works
A debt-to-income ratio helps lenders evaluate your ability to repay loans. If you have a low ratio, you may be able to take on additional payments.
Assume your monthly gross income is $3,000. You have an auto loan payment of $440 and a student loan payment of $400 each month. Calculate your current debt-to-income ratio as follows:
Divide the total of your monthly payments ($840) into your gross income:
$840 debt payments / $3,000 gross income = .28 or 28% debt-to-income ratio.
Now, assume you still earn $3,000 per month gross, and your lender wants your debt-to-income ratio to be below 43%. What is the maximum you should be spending on debt each month? Multiply your gross income by the target debt-to-income ratio:
$3,000 gross incomex 43% target ratio = $1,290 or less monthly target for debt payments
Total debt payments lower than the target amount mean you’re more likely to get approved for a loan.
What Is the Maximum Allowable DTI?
The specific debt-to-income requirements vary from lender to lender, but conventional loans often range from 36% to 45%.
For your mortgage to be a qualified mortgage, the most consumer-friendly type of loan, your total ratio must be below 43%. With those loans, federal regulations require lenders to determine you have the ability to repay your mortgage. Your debt-to-income ratio is a key part of your ability.
Lenders may look at different variations of the debt-to-income ratio: the back-end ratio and the front-end ratio.
Back-End Ratio
A back-end ratio includes all your debt-related payments. As a result, you count the payments for housing debt as well as other long-term debts (auto loans, student loans, personal loans, and credit card payments, for example).
Front-End Ratio
The front-end ratio only includes your housing expenses, including your mortgage payment, property taxes, and homeowners insurance. Lenders often prefer to see that ratio at 28% or lower.
Note
If monthly payments are keeping you from making progress on financial goals, consider working with a nonprofit credit counseling agency. A professional can help you make a plan and take control of your debt.
Improving Your DTI Ratio
If a high debt-to-income ratio prevents you from getting approved, you can take the following steps to improve your numbers:
Pay off debt: This logical step can reduce your debt-to-income ratio because you’ll have smaller or fewer monthly payments included in your ratio.
Increase your income: Getting a raise or taking on additional work improves the income side of the equation and reduces your DTI ratio.
Add a co-signer: Adding a co-signer can help you get approved, but be aware that your co-signer takes a risk by adding their name to your loan.
Delay borrowing: If you know you’re going to apply for an important loan, such as a home loan, avoid taking on other debts. You can apply for additional loans after the most important purchases are funded.
Make a bigger down payment: A large down payment helps keep your monthly payments low.
In addition to improving your chances of getting a loan, a low debt-to-income ratio makes it easier to save for financial goals and absorb life’s surprises.
Key Takeaways
A debt-to-income ratio provides a quick view of your monthly finances.
A low ratio indicates you are spending a small portion of your income on debt.
Lenders may set maximum limits on your debt-to-income ratio.
You can improve your ratios by paying down debt, borrowing less, or earning more income.
35% or less is generally viewed as favorable, and your debt is manageable. You likely have money remaining after paying monthly bills. 36% to 49% means your DTI ratio is adequate, but you have room for improvement. Lenders might ask for other eligibility requirements.
35% or less: Looking Good - Relative to your income, your debt is at a manageable level. You most likely have money left over for saving or spending after you've paid your bills. Lenders generally view a lower DTI as favorable.
Debt-to-income (DTI) ratio is an immediate snapshot of your creditworthiness. It measures your monthly recurring debt (including loans, credit card payments, and rent or mortgage payments) in relation to your gross income. Lenders typically want to see a DTI of 35% to 40% or less.
What payments should not be included in debt-to-income ratio? Expand. The following payments should not be included: Monthly utilities, like water, garbage, electricity or gas bills.
Your debt-to-income (DTI) ratio is how much money you earn versus what you spend. It's calculated by dividing your monthly debts by your gross monthly income. Generally, it's a good idea to keep your DTI ratio below 43%, though 35% or less is considered “good.”
Lenders, including anyone who might give you a mortgage or an auto loan, use DTI as a measure of creditworthiness. DTI is one factor that can help lenders decide whether you can repay the money you have borrowed or take on more debt. A good debt-to-income ratio is below 43%, and many lenders prefer 36% or below.
Paying down debt is the most straightforward way to reduce your DTI. The fewer debts you owe, the lower your debt-to-income ratio will be. Suppose that you have a car loan with a monthly payment of $500. You can begin paying an extra $250 toward the principal each month to pay off the vehicle sooner.
Your debt-to-income ratio (DTI) compares how much you owe each month to how much you earn. Specifically, it's the percentage of your gross monthly income (before taxes) that goes towards payments for rent, mortgage, credit cards, or other debt.
Generally speaking, the lower a DTI ratio you have, the less risky you appear to lenders. The preferred maximum DTI ratio varies. However, for most lenders, 43 percent is the maximum DTI ratio a borrower can have and still be approved for a mortgage.
A credit score—used to measure risk—is entirely independent of how much money you make and instead is based on how you manage your finances, i.e., how much you owe and how you pay it back. High net worth individuals can still miss payments, rely too heavily on credit, or open too many accounts.
The ratio includes your total debt payments, housing costs, and loan payments, but doesn't take utility bills, grocery expenses, or healthcare costs into consideration. Experts recommend trying to keep your DTI below 43%, but ratios at 36% or lower may help you qualify for even lower rates.
What is not included in my debt-to-income ratio? Your debt-to-income ratio does not factor in your monthly rent payments, any medical debt that you might owe, your cable bill, your cell phone bill, utilities, car insurance or health insurance.
Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.
A good debt-to-income ratio is below 43%, and many lenders prefer 36% or below. Learn more about how debt-to-income ratio is calculated and how you can improve yours.
If the ratio is over 1, a company has more debt than assets. If the ratio is below 1, the company has more assets than debt. Broadly speaking, ratios of 60% (0.6) or more are considered high, while ratios of 40% (0.4) or less are considered low.
If your debt ratio does not exceed 30%, the banks will find it excellent. Your ratio shows that if you manage your daily expenses well, you should be able to pay off your debts without worry or penalty. A debt ratio between 30% and 36% is also considered good.
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