How to calculate your debt-to-income ratio

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Your debt-to-income ratio, or DTI ratio, is your total monthly debt payments divided by your total gross monthly income.

Your DTI helps lenders determine whether you’ll be able to pay back your loan on time and make your monthly payments. The higher your DTI, the more you may struggle to pay your monthly debts because there is less room for error in the event of an emergency or poor budgeting. The lower your DTI, the more lenders see you as a reliable borrower.

Before taking out a loan, calculate your debt-to-income ratio, or DTI. That way you have an understanding of what lenders are looking at when determining how risky a borrower you are, and whether you have enough money each month to make your monthly payments.

How to calculate your debt-to-income ratio

The first step is to add all of your monthly debt payments. Here’s an example:

  • Mortgage: $1,600
  • Auto loan: $300
  • Minimum credit card payments: $300
  • Student loan: $200

Total debt: $2,400

Now add your total gross income, or what you earn before taxes are taken out. If you only have a day job, check your pay stub for your pretax earnings. If you also have a side hustle, add that into the total. Here’s another example:

  • Monthly gross income from day job: $5,000
  • Side hustle monthly gross income: $1,000

Total: $6,000

To calculate your DTI, divide your debt by your gross monthly income. For this example, it would be $2,400 / $6,000. Your total DTI would be 0.40, or 40 percent.

The lower your debt relative to your current gross monthly income, the lower your DTI. Say you paid off your car and student loans, you’d slash $500 from your monthly debt, and your new debt total would be $1,900 per month. When you divide that lower amount by your $6,000 income, your new DTI would be about 32 percent.

Your total monthly debt includes anything you’re required to pay, such as:

  • Mortgage or rent payment.
  • Student loans.
  • Auto loan.
  • Personal loan.
  • Minimum credit card payments.
  • Alimony.
  • Child support.

Monthly payments to utility bills, food and insurance aren’t considered in your DTI calculation.

What is a good debt-to-income ratio?

The higher your DTI, the riskier you appear to lenders. Each lender has different DTI standards you must meet to qualify for a loan, but most lenders use a 43 percent DTI as a standard benchmark.

Because each lender is different, see if you can find what their preferences are. Typically, a DTI of 50 percent or more is concerning. You don’t have much extra money to spend each month, which means you’ll have a harder time making payments on a loan, let alone other expenses. If your DTI is between 36 percent and 49 percent, it’s good but there’s still room for improvement. You might want to consider lowering your DTI before applying for a loan.

A DTI below 35 percent is good and manageable. It shows that you have enough money to take on new debt and pay it back on time. If an emergency came up, you most likely wouldn’t fall behind on payments.

Keep in mind that the requirements are different for each lender and what type of loan you’re taking out. Your DTI for a mortgage might not be the same as a personal loan.

Why your debt-to-income ratio matters to lenders

Your debt-to-income ratio is an important component in determining your overall risk. It can tell you how much of your money is going toward outstanding debt. It might even help you adjust your budget to put more money into paying off debt so you can eventually lower your DTI and have a better chance of being approved for a loan at a good interest rate.

For lenders, a low DTI shows that you don’t carry much debt baggage. It’s an important risk measurement, just like your credit score. Both are used to determine if you’re worth lending to.

On many loan applications, you’ll see questions about your income and monthly debt. The type of loan you want, the amount you want to borrow, the lender you choose, your income, debt and credit score are all taken into account by loan underwriters. Since there are many different variables, you should consider shopping around to compare lenders to see which ones will offer you the lowest interest rates and best repayment terms.

If you have the time and money, do your best to lower your DTI as much as you can before taking on new debt, like a new car loan. It will not only help you qualify for a loan, but may help you get a lower interest rate. You can also work on increasing your income by finding a higher-paying day job or getting a side hustle.