Your debt-to-income ratio (DTI) is the percentage of debt you have relative to the amount of money you earn. It’s a way to determine how much additional debt you can afford. To calculate your DTI, add up all of your monthly debts and divide that figure by your gross monthly income (before taxes).
Lenders will use your DTI information when deciding whether to approve you for a personal loan. Once you know your DTI, you can take steps to improve it if necessary.
How does a debt-to-income ratio work?
A low debt-to-income ratio shows lenders you may have the budget available to add another loan payment and still manage your other financial obligations.
Lenders consider DTI alongside other factors such as your credit score, income, and payment history. Keep in mind that DTI requirements vary by loan product and lender.
There are two types of debt-to-income ratios:
- The front-end ratio is your housing debt divided by your income (typically used by mortgage lenders).
- The back-end ratio takes into account all of your debts, not just your housing debt. That includes student loans, auto loans, personal loans, and any other type of debt you are making payments on.
Lenders may require that your front-end DTI and back-end DTI fit within certain parameters. For example, if you’re seeking a mortgage, lenders will typically require that your front-end DTI be 28% or less.
How to calculate your DTI
To calculate your debt-to-income ratio, you must divide your debt by your pretax monthly income.
First, add up each of your monthly debt payments. These may include:
- Rent or mortgage
- Auto loan
- Student loan
- Minimum credit card payment
Next, divide your total debt by your total monthly income before taxes. Multiply this number by 100 to get the percentage.
| For example: Suppose you earn $6,000 per month before taxes. You pay $1,600 a month in rent, owe $400 a month for your car, and have a student loan payment of $200 per month. Add them together to get your monthly debt, which is $2,200. Divide $2,200 by your gross monthly income ($6,000) and you get 0.37, or 37%. Your DTI ratio can change if your income goes up or down, or if your expenses change. For instance, suppose you got a 3% raise, giving you an extra $180 per month, but your expenses stay the same. Now your DTI is 36%, because 2,200 divided by 6,180 is 36%. Important: Don’t include other monthly payments in your calculation that aren’t debts. For instance, don’t include your utility bills, subscriptions, or entertainment costs. However, if you owe child support or alimony, do include those payments in your monthly debt calculations. |
Not sure of your monthly gross income? If you’re a W-2 earner, you can find your gross income on your pay stub. If you’re paid weekly or biweekly, make sure you include a month’s worth of income when calculating your DTI.
If you’re self-employed or have irregular income, it can be a little more difficult to calculate your DTI, since your income changes month-to-month. You can take an average of the last three or six months to get an idea, or just estimate a typical month. If your lender is trying to discover your DTI, they may require additional documentation that shows your income over time, such as W-2s or tax returns.
Understand your DTI
Your debt-to-income ratio can influence the loan amount you’re approved for, as well as the interest rate and other terms. It can also indicate whether you’ve taken on too much debt, or if you have room in your budget for a new loan payment. A debt-to-income ratio that’s too high will make it tough to qualify for a personal loan.
Carla Blair-Gamblian, a credit expert with Veterans United Home Loans who specializes in financial counseling, recommends borrowers shop around when searching for a loan.
“Check with a few different lenders on loan products and score requirements to see what is available and works best financially for you and your family,” she said.
While each lender sets its own requirements for DTI, you can get a general idea of how your DTI may affect your loan options.
Here are some general guidelines:
- Up to 36% DTI: Most lenders typically approve borrowers with a DTI of 36% or below.
- 37 to 49% DTI: Your debt is manageable, but lenders may want to see evidence that you could handle additional debt.
- 50% DTI or higher: If your DTI is in this range, you may have difficulty qualifying for a loan, as lenders may be uncertain about your ability to repay.
If you’d like to improve your odds of getting approved for a personal loan, you can take steps to lower your DTI, which should help.
Strategies to lower your ratio
There are two basic ways to improve your DTI: Earn more money, or pay off debt.
To increase your earnings, you can consider picking up more hours at work, asking for a raise, or even changing jobs to one with higher pay. Another option is to get a side job or freelance gig to earn extra income.
If getting a raise or side gig isn’t an option, work on lowering your debts instead. There are several methods you may find successful:
- Create (and stick to) a budget: Making a plan for where your money will go can help you stick to your goals. Look for spending categories where you can cut back, then apply the money you saved to your debt.
- Use the debt snowball method: This method helps you build momentum by prioritizing paying off your smallest debt first. You’ll still make the minimum payments on all your debts, but you’ll focus on the smallest one, then apply those freed-up funds to your next-smallest debt.
- Use the debt avalanche method: With this method, you make the minimum payments on all of your debts, and apply any extra funds to the debt with the highest interest rate until it’s paid off. You’ll continue to do so until all your debts are repaid.
For example, suppose you have two credit cards: one at 18% APR and one at 20% APR. You owe $1,200 on one card and $800 on another.
| The debt snowball method: You’d make the minimum payment on each account, and put any extra funds toward the card with the $800 balance until it’s paid off. Then you’d take that extra money and put it toward the card with the $1,200 balance until it’s paid off. The debt avalanche method: You’d pay the minimum on both cards and put any extra funds toward the card with the 20% APR until it’s paid off, followed by the card with 18% APR. |
With each method, your goal is to steadily and methodically work on paying down your debts.
FAQ
How does DTI affect your credit score?
Your DTI doesn’t affect your credit score and it’s not included in your credit report. However, your DTI still influences whether you qualify for certain loans, so it’s important to keep your debt under control.
What is the ideal debt-to-income ratio?
Ideally, your debt-to-income ratio would be below 36%. That’s typically the cutoff many lenders stick to when evaluating borrowers who apply for personal loans. In some cases, such as for certain government-backed mortgages, you may be approved for a loan with a debt-to-income ratio as high as 50%, but it’s best to try to keep your DTI as low as possible.
How is a debt-to-income ratio different from a debt-to-limit ratio?
Though they seem similar, the debt-to-income ratio measures a different metric than the debt-to-limit ratio, which is also called credit utilization.
Instead of measuring debt as compared to income, credit utilization measures debt as compared to the total credit available to you. In other words, how much of your available credit are you using? As with debt-to-income ratios, lenders prefer borrowers that have a low credit utilization — preferably below 30%.