Unlike your credit score, debt-to-income ratio is easy to calculate. Just take your recurring monthly debt, divide it by your gross monthly income, and multiply the amount by 100. The lower this number, the better off you will be. In general, lenders like to see a DTI ratio of 36% or lower.
Keep reading to learn more about how to calculate debt-to-income ratio and why it matters.
What Exactly is DTI?
Just as the name implies, your debt-to-income ratio is simply the amount of debt you have as compared to your overall income. Lenders use this number to determine if they should extend your credit or lend you money. A low DTI shows lenders that you can handle taking on more debt.
Why Does Debt-to-Income Ratio Matter?
Debt-to-income ratio matters because it is a numeric representation of your personal finances. It is a simple, objective means for lenders to make decisions about loan applications and credit cards. This makes it incredibly valuable when you want to lease a car or take out a home loan.
Knowing your own debt-to-income ratio also helps you make smart financial decisions. It gives you a good picture of whether you can handle taking on additional debt like student loans, a personal loan, or a mortgage. It can also help you determine your budget for big purchases like a home or new car.
How to Calculate Debt-to-Income Ratio
Calculating your debt-to-income ratio is simple, and you can do it yourself. First, add up all of your monthly debt obligations. This includes:
- Monthly mortgage payment (principal, interest, taxes, and insurance)
- Home equity loan payment
- Child support and alimony
- Car loan payment
- Student loan payment
- Minimum monthly payment on credit card debt
- Other monthly debt obligations that will not be paid off within 6-10 months
Second, figure out your gross monthly income or pre-tax income. This includes:
- Wages
- Salaries
- Tips and bonuses
- Social Security
- Pension
- Child support and alimony
- Other additional income
Finish up by dividing your recurring monthly debt by your gross monthly income. Multiply the quotient by 100 to get your debt-to-income ratio as a percentage.
| Example of a DTI Ratio Calculation |
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| Diego plans to take out a car loan. Before applying online, he wants to calculate his DTI to see if taking on additional debt seems plausible.
Diego has these monthly expenses:
Diego earns this much each month:
Diego’s debt-to-income ratio = ($1,978 / $6,500) x 100 = 30.4% To keep his DTI in the good range (0-36%), Diego’s monthly car payment should not exceed $362. |
What is a Considered a Good Debt-to-Income Ratio?
When it comes to your credit score, higher is always better. But with your debt-to-income ratio, that is not the case. The closer your DTI ratio is to zero, the better.
As a general rule of thumb, lenders like to see a DTI of 36% or less. This indicates that you can handle additional monthly debt. The lower your debt-to-income ratio is, the higher the chance of your lender approving your mortgage, car loan, or credit extension request. Lenders also look at your credit score and many also use the 28/36 rule to assess your borrowing capacity.
What is the 28/36 Rule?
The 28/36 rule helps lenders more accurately calculate whether a household or individual can take on more debt. Under this rule, a household should spend no more than 28%(front end) of its gross monthly income on total housing expenses and a maximum of 36%(back-end) on total debt. Total debt includes the debt obligations listed above like mortgage, student loans, and credit card debt.
With this rule, mortgage lenders calculate two different numbers–your front-end DTI and your back-end DTI. The front-end DTI is calculated using only your proposed mortgage payment, including principal, interest, taxes, HOA fees, and insurance. The back-end DTI is calculated using your total monthly debts.
| Example of 28/36 DTI Ratio |
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| Carmen makes $4,000 per month pre-tax. She owes $900 each month in student loan debt, car payments, and alimony. She is applying for a home mortgage with a monthly cost of $700.
Her front-end DTI is as follows:
Her back-end DTI includes her monthly debt plus the proposed home mortgage:
Carmen’s front-end DTI ratio is well below the recommended 28%. However, her back-end DTI is a little high. Luckily, some mortgage companies will still consider Carmen’s application, especially if she is applying for an FHA loan. These loans have a maximum allowable DTI of 43% |
Drawbacks of a High Debt-to-Income Ratio
How high is too high when it comes to your DTI? As a general rule of thumb, a DTI of 50% indicates that you have way too much debt. At least 50% of your pre-tax monthly income goes toward debt. That leaves you with little left over for food, utilities, gas money, entertainment, education, charitable giving, and savings. A DTI from 37% to 49% is not ideal either, but it is more manageable.
Spending a lot of your income on debt does more than just affect what groceries you can afford and your vacation fund. A high DTI may also indicate that:
- You will have trouble acquiring a mortgage, a car loan, or a personal loan in case of emergencies
- You struggle to afford your monthly bills and to keep food on the table
- Your credit score is in bad shape since many factors that lead to a high debt-to-income ratio also negatively impact credit scores
How Do You Lower Your Debt to Income Ratio?
If you are unhappy with your debt-to-income ratio, you have two options: either make more money or pay off your debt. This may seem daunting, but it is very doable. Here are a few ways to get started:
Increase Your Income
Any boost to your income will lower your debt-to-income ratio. Just a couple hundred dollars could lower your DTI enough to pull you into the golden 36% or less zone.
Consider this scenario: You currently have $1,500 of monthly recurring debt and earn roughly $4,000 each month. Your current DTI is 38%–just outside of the good range. If your debt stays the same, but your earnings increase to by just $250 per month, your new DTI is now 35%.
Here are some ways to boost your DTI Ratio:
Work Overtime
Take advantage of any opportunity to work overtime, especially if you plan to apply for a mortgage soon. Not only will you improve your DTI, but you will accumulate extra cash that you can use toward a down payment or paying off debt.
Request a Salary Increase
Ask your boss for a raise. This may require finding extra grant money somewhere or creating a formal proposal.
Work a Part-Time Job
Working a part-time job in addition to your current job can help you get your finances in order. Even just working another 5-10 hours a week could make all the difference when it comes to getting approved for a loan.
Start a Side Hustle
Side hustles like offering ridesharing services, babysitting, opening up an online craft store, blogging, selling your belongings, or doing handyman jobs allow you to earn more money when it is most convenient to you. Get creative and choose something that you enjoy.
Manage Your Debt
Managing your debt will have the biggest impact on your debt-to-income ratio. It can be hard to get in the habit of debt management, but it is doable.
Pay More than the Minimum
Pay off your debt faster to lower your debt-to-income ratio. This requires making more than just the minimum payments on your debt. Be smart about how you do this to get the most out of your efforts. There are two schools of thought with paying off debt. On one side, you can try to eliminate your smallest debt first to gain momentum. You could pay your $1,000 federal student loan before your $20,000 privathue student loan. On the other, you can attack the debt with the largest interest rate first to save more money in the long run. In this case, you would pay your $20,000 private student loan with the 7% interest rate before your $1,000 federal student loan with the 4.45% interest rate.
Stop Accumulating Debt
Your debt-to-income ratio increases significantly when you take on new debt. Credit card debt is the easiest to accumulate because you already have access to this borrowed money. Simply avoid or cut back on using your credit card. This can help lower your DTI or at least keep it steady until you can pay off some debt.
Hold Off on Large Purchases
Credit cards make it easy to purchase large items that you cannot afford with your regular monthly income. Hold off on buying a new TV, vacation packages, or other extravagant purchases until you have all or at least some of the money saved. The more cash you have to put toward the purchase, the less credit you will need to make up the difference. This will help keep your DTI ratio low.
Track Your Progress
The only way to know if you are meeting your goals is to keep track of your DTI ratio. As you pay off debt or increase your monthly income, redo your DTI ratio calculation. Seeing progress will encourage you to keep working toward eliminating your debt load.
Debt-to-Income Ratio and Student Loans
To understand the full impact of your student loans, you need to understand the role they play in your debt-to-income ratio. As mentioned above, student loan monthly payments count as monthly recurring debt. This means that both your federal and private student loans help determine your DTI ratio. Their presence in your DTI ratio calculation affects two types of borrowers in a big way.
Recent Graduates
It may not seem like a big deal now, as student loans are likely your first debt as a recent graduate. But, your student loans can significantly affect your future borrowing.
| Example of Student Loans Impact on DTI Ratio |
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Adults Going Back to School
If you are a working adult who is heading back to school, your DTI ratio will affect your student loans in a different way. It will give you a clear picture of how much student loan debt you can afford to take on both now and in the future.
| Considering Your DTI Ratio When Taking Out New Student Loans |
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Keep in mind that your anticipated DTI ratio should only serve as a guideline as you consider your loan options. Anticipated earnings are not guaranteed, so be conservative with your calculations and only take out the minimum amount of loans needed.
Commonly Asked Questions
Are utilities included in the DTI?
No. Your DTI only includes your recurring monthly debt payments like your mortgage, student loan, or child support payments. Things like trash, sewer, water, and electricity do not go into this calculation. However, they are worth keeping track of if you are using your DTI to figure out whether you can afford taking on additional monthly debt.
Where do lenders get the data to calculate my DTI?
An underwriter pulls your financial information from your credit report. Your credit report will give them a good picture of your financial health and enable them to see all of your monthly debt. They receive information about your income directly from you as part of the application process. You can obtain your own credit report for free.
What is a good debt-to-income ratio for a car loan?
In general, 36% is a good debt-to-income ratio for a car loan. However, some lenders accept a maximum of 40% if the borrower has a good credit score. To secure the best interest rates, try to boost your credit score and lower your debt-to-income ratio prior to applying.
What is the Maximum Allowable DTI for an FHA Loan?
The FHA loan program helps you finance or refinance your home with a low down payment and flexible terms. Its application requirements give great weight to a borrower’s debt-to-income ratio. The 2018 maximum allowable DTI ratio for an FHA loan is 43% for borrowers with at least a 620 FICO credit score. Instead of a 28/36 rule, FHA lenders generally use a 31/43 rule to assess applicants.
