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 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 to 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 debt-to-income ratio
To calculate debt to income ratio, first add up all your monthly debt payments. Separately, add up your total gross income, or what you earn before taxes are taken out. Next, divide your debt by your gross monthly income to get your debt-to-income ratio.
1. Add up your monthly debts
The first step toward calculating your debt-to-income ratio is to add up all of your monthly debt payments. For fixed-payment loans like rent, an auto loan or a personal loan, you will use your regular monthly payment. For variable payments such as credit card payments or a home equity line of credit, use your minimum monthly payment. Your monthly debts will include any debts that are listed on your credit report.
For your mortgage payment, you will calculate with the full PITI (principal, interest, taxes and insurance). If you escrow your taxes and insurance, this will be your regular monthly payment. 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 are applying for a loan, your lender will likely require documentation of all of your income.
If you are a W-2 employee, documentation will likely come from your W-2 form and/or your last several paystubs. If you are self-employed or have income coming in from a side hustle, your lender will likely be looking 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, 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.
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 your DTI for a personal loan.
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 also help you get a lower interest rate. You can also improve your DTI by increasing your income or consolidating debts at a lower interest rate.
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