Your debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes toward paying your debt. It's important not to confuse your debt-to-income ratio with your credit utilization, which represents the amount of debt you have relative to your credit card and line of credit limits.
Many lenders, especially mortgage and auto lenders, use your debt-to-income ratio to figure out the loan amount you can afford based on your current income and the amount you're already spending on debt.
For example, a mortgage lender will use your debt-to-income ratio to figure out the mortgage payment you can handle after all your other monthly debts are paid.
You can easily calculate your debt-to-income ratio to figure out the percentage of your income that goes toward paying down your debts each month.
Total Your Monthly Debt
You can calculate your debt-to-income ratio by dividing your gross monthly income by your monthly debt payments:
DTI = monthly debt / gross monthly income
The first step in calculating your debt-to-income ratio is determining how much you spend each month on debt.
To start, add up the total amount of your monthly debt payments, including the following:
- Mortgage or rent
- Minimum credit card payments
- Car loan
- Student loans
- Alimony/child support payments
- Other loans or lines of credit
Let's assume Sam has the following debt expenses:
- Mortgage = $950
- Minimum credit card payments = $235
- Car loan = $355
So, $950 + $235 + $355 = $1,540 total monthly debt payments
You don't need to include payments you make for car insurance, utilities, health insurance, groceries and other monthly expenses that don't involve financing. As a general guideline, if it doesn't show on your credit report, it's not factored into your debt-to-income ratio by lenders.
Total Your Monthly Income
The next step to determining your debt-to-income ratio is calculating your monthly income.
Start by totaling your monthly income. Add up the amount you receive each month from:
- Gross income from a W-2 job or self-employment
- Bonuses or overtime
- Alimony/child support
- Other income from various sources
Remember, Sam spends $1,540 each month on debt payments. Each month, they receive income as follows:
- Monthly gross income = $3,500
- Child support = $500
Sam's total monthly income = $3,500 + $500 = $4,000.
Note: Multiply a weekly income by 4 and bi-monthly income by 2 to calculate your total monthly income. Or, if you know your annual salary, divide by 12 to get to your monthly income.
Doing the Simple Math
Once you've calculated what you spend each month on debt payments and what you receive each month in income, you have the numbers you need to calculate your debt-to-income ratio. To calculate the ratio, divide your monthly debt payments by your monthly income. Then, multiply the result by 100 to come up with a percent.
In our example, Sam's monthly debt payments total $1,540 and their monthly income totals $4,000. So, divide $1,540 by $4,000 and then multiply by 100:
$1,540 / $4,000 = 0.385 X 100 = 38.5%
Sam has a debt-to-income ratio of 38.5%.
What Your Debt to Income Ratio Means
Your final result will fall into one of these categories.
- 36% or less is the healthiest debt load for the majority of people. If your debt-to-income ratio falls within this range, avoid incurring more debt to maintain a good ratio. You may have trouble getting approved for a mortgage with a ratio above this amount.
- 37% to 42% isn't a bad ratio to have, but it could be better. If your ratio falls in this range, you should start reducing your debts.
- 43% to 49% is a ratio that indicates likely financial trouble. You should start aggressively paying your debts to prevent an overloaded debt situation.
- 50% or more is an extremely dangerous ratio. This means that more than half of your income goes toward debt payments each month. You should be aggressively paying off your debts. Don't hesitate to seek professional help.
In our example, Sam has a debt-to-income ratio of 38.5%. While this isn't a bad ratio, it could become worse if Sam increases their monthly debt payments without increasing their income.