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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 will 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 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 to understand 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.
1. Add up your monthly debts
The first step toward calculating your debt-to-income ratio is adding up all your monthly debt payments. Your list of monthly debts will include any debts listed on your credit report, including:
- Auto loan payments
- Child support and alimony payments
- Credit card payments
- Home equity loan payments
- Home equity line of credit payments
- Line of credit payments
- Mortgage payments
- Personal loan payments
- Store card payments
- Student loan payments
- Timeshares payments
If you co-signed any loans for friends or relatives, they should also be accounted for on your list of debts.
For fixed-payment loans like rent, an auto loan or a personal loan, you will use your regular monthly payment. Use your minimum monthly payment for variable payments such as credit card payments or a home equity line of credit.
For your mortgage payment, you will calculate with the full PITI (principal, interest, taxes and insurance). This will be your regular monthly payment if you escrow your taxes and insurance. If you don’t escrow, your lender will likely take your annual tax and insurance payments, divide them by 12 and include them as part of your mortgage payment for purposes of DTI calculation.
Here is an example of what it could look like after considering these monthly debts:
- Mortgage: $1,600
- Auto loan: $300
- Minimum credit card payments: $300
- Student loan: $200
Total monthly debts: $2,400
2. Add up your monthly gross income
Next, you’ll want to add up your monthly gross income. Consider all of your income. When you apply for a loan, your lender will likely require documentation of your income.
If you are a W-2 employee, documentation will likely come from your W-2 form and/or your last several pay stubs. If you are self-employed or have income from a side hustle, your lender will likely look at your business tax returns. If you have money coming in from a side hustle but don’t have a business tax return or other documentation, your lender may not allow you to use that income as part of your DTI calculation.
If you have properties you rent out, you need to calculate that too. The mortgage payments on your rental properties are included as part of your monthly debts, but you may not be able to use all of the rental income as part of your income calculation. Many lenders will only allow you to count 75% of the monthly rent towards income. That leaves a buffer for maintenance and vacancies.
Here is how those calculations could go:
- Monthly gross income from day job: $5,000
- Side hustle monthly gross income: $1,000
Total monthly gross income: $6,000
3. Divide your monthly debts by your monthly gross income.
For this example, you would divide your monthly debt payments ($2,400) by your total monthly gross income ($6,000). In this case, your total DTI would be 0.40, or 40 percent.
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 benchmark.
A DTI above 43 percent could make it more difficult for you to obtain a loan. In particular, this applies to qualified mortgages. In many cases, 43 percent is the highest DTI ratio a borrower can have and still be approved for a qualified mortgage.
Typically, a DTI of 50 percent or more is concerning. You don’t have much extra money to spend each month, so 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.
The requirements differ for each lender and the type of loan you take out. Your DTI for a mortgage might not be the same as your DTI for a personal loan.
Your DTI can make or break your chances at a loan. So, do your best to lower your DTI as much as possible before taking on new debt, like a new car loan.
It will not only help you qualify for a loan but may also help you get a lower interest rate. You can also improve your DTI by lowering expenses to make higher debt payments, increasing your income or consolidating debts at a lower interest rate.
Frequently asked questions
After calculating your debt-to-income ratio (DTI), inquire with the lenders you are considering if you haven’t yet done so about their requirements. If your DTI is at or below their threshold and you meet the other eligibility criteria, you can move forward with the application process.Otherwise, you want to hold off until you can pay down your balances and get your DTI to an acceptable level. The lender may allow a much higher DTI than 50 percent, which is considered risky. So, even if you’re eligible for a loan, you should still focus on minimizing the balances owed to lenders and creditors.
If your DTI disqualifies you for a loan, consider taking the necessary steps to reduce it. Evaluate your spending plan, reduce expenses and use these funds to make extra payments towards your debt each month. It’s equally important to stop using credit cards or opening new credit accounts while paying down balances. Be sure to recalculate your DTI regularly so you’ll know when it’s at a percentage that’s acceptable to the lender.
It is not necessary to notify lenders if your DTI changes. However, credit card issuers may calculate this figure if you apply for a credit limit increase. Current lenders will also compute your DTI if you apply for an additional debt product.