One of the many variables lenders use when deciding whether or not to loan you money is your debt-to-income ratio or DTI. Your DTI reveals how much debt you owe compared to the income you earn. Higher debt paired with lower income results in a higher DTI percentage, whereas lower debt with higher income yields a smaller percentage. Here’s how to calculate your DTI and find out how much debt you owe compared with your income.
What Is a Debt-to-Income Ratio?
Your DTI ratio is your minimum monthly debt payments divided by your gross monthly income. Recurring monthly debt refers to financial obligations such as loans and monthly bills that are not optional like entertainment expenses.
Recurring debt includes:
Mortgage payments or rent
Credit card payments
Auto loan payments
Calculate Your Debt-to-Income Ratio
To find out what your debt-to-income ratio is, use a debt-to-income ratio calculator or simply add up your minimum recurring debts — that is, the least amount you’re required to pay on each debt every month. Then divide that number by your gross monthly income amount. The resulting number is your DTI
Why Do I Need to Know My Debt-to-Income Ratio?
Lenders view your debt-to-income ratio as a good predictor of your ability to manage your recurring monthly bills along with the potential monthly payment on the loan they might give you. If you plan on borrowing money, it’s wise to know your DTI and how to reduce your ratio of debt compared to income.
For instance, when applying for a credit card, lenders look at more than just your credit score and credit history to determine if you’re capable of adding another credit card payment to your debt-to-income load. If your DTI is high, they might deny another card.
When applying for a mortgage loan, lenders will look at your debt-to-income ratio to consider your ability to repay. If your DTI is high, they might require extra safeguards as part of the loan agreement, such as a bigger down payment or proof of adequate savings or cash reserves.
You can lower your DTI ratio by increasing your income — you might decide it’s time to seek a higher-paying job or ask for a raise. You can also lower DTI by reducing your debt load. If you get a windfall or large tax refund, consider paying off a high payment or high-interest loan or credit card. Or you can use a combination of both to reduce your debt.
What Is a Good Debt-to-Income Ratio?
The Department of Housing and Urban Development is the government entity that looks at the average debt-to-income ratio and establishes the requirements for housing loans, including the DTI limits. A DTI less than 43 percent is a good number to aim for because it’s the highest ratio a borrower can have and still get approved for a qualified mortgage, according to the Consumer Financial Protection Bureau. A qualified mortgage has specific stable features that make it more likely you’ll be able to afford the payments.
Exceptions do exist, however: Even if your DTI score is higher than 43 percent, small lenders — those with under $2 billion in assets who made no more than 500 mortgages in the prior year — are allowed to offer Qualified Mortgages. On the other hand, larger lenders can still make a mortgage loan even if it is not a Qualified Mortgage, as long as they can reasonably assure — following CFPB rules — that you have the ability to repay the loan.