How to Calculate the Debt-to-Income Ratio
Your debt-to-income ratio (DTI) is an important part of your financial situation, and lenders usually take it into account when reviewing loan applications.
Your DTI is calculated by dividing your total monthly debt payments by your gross monthly income. The resulting percentage tells lenders whether you are likely to be able to repay the additional loan you are requesting.
As a general rule, many lenders require borrowers to have a DTI of 40% or less. However, individual lenders set their own requirements and some lenders will accept applicants with higher DTIs.
Before applying for a personal loan, it’s important to calculate your debt-to-equity ratio so you know where you stand and what you might qualify for.
Debt-to-income ratio statistics
While average household income has increased significantly over the years, average household debt has grown faster. Especially now, with inflation on the rise and people paying more for basic necessities like food, rent and gas, many are going deeper into debt.
Debt-to-income ratio statistics
- The average American has $90,460 in debt, including all types of consumer debt.
- The median household income in the United States was $79,900 in the first quarter of 2021.
- The average US household debt was $145,000.
- Personal lenders generally look for a debt to income ratio of 40% or less when reviewing applications.
What is the debt to income ratio?
Your debt to income ratio is simply your total monthly debt divided by your total monthly income.
The lower your DTI ratio, the better your chances of qualifying for another loan. To calculate your DTI, add up all your monthly debt payments and divide by your gross monthly income. Your gross monthly income is the money you earned in a month before taxes and other deductions are taken.
For example, a borrower with a monthly mortgage payment of $900, a monthly car payment of $400, a minimum credit card payment of $100, and a gross monthly income of $4,000 would have a debt-to-equity ratio of 35%.
Examples of debts that would be calculated in your DTI include mortgages or lease payments, car loans, credit cards, personal loans, home equity loans, student loans, child support, etc. Your DTI ratio does not include monthly utilities, car insurance costs, cable bills, cell phone bills, health insurance costs, or groceries/food.
The higher your debt-to-equity ratio, the more debt you have and the less likely you are to qualify for additional loans.
How to calculate the DTI ratio?
To calculate your debt ratio, start by adding up your monthly bills. You should include your rent or mortgage payment, car payment, credit card payments, child support payments, and any loans you currently have.
Once you have done this, you will divide this total by your monthly income before taxes. This will leave you with a decimal number, which you can multiply by 100 to get your DTI ratio percentage.
Step 1: Add up the expenses
- Credit card loans/payments
- Child Support / Alimony Payments
Step 2: Divide it by your monthly gross income
- Rental income
- Child Support / Alimony Payments
Step 3: Convert it to a percentage
- Multiply the number by 100
- The percentage is your debt to income ratio
There are two components of your debt-to-income ratio that lenders assess when reviewing loan applications. These are your front-end DTI and your main DTI. Your frontal DTI is your housing ratio. This includes housing expenses such as mortgage payments, property taxes, homeowners association dues, and homeowners insurance. Your main DTI is your front-end DTI plus all other monthly DTI debts. This ratio takes into account things like credit card bills, auto loans, and personal loans. Lenders tend to focus on your primary DTI because it represents all of your monthly expenses.
If you need help calculating your debt ratio or want to check your calculation, try using a DTI calculator.
What is a good DTI ratio?
Although each lender has their own debt-to-equity requirements, it’s harder to qualify for loans if you have a debt-to-equity ratio of 43% or higher. A good debt-to-income ratio is usually below 36%. Having a good debt ratio makes it easier for you to qualify for mortgages, home loans, auto loans, and personal loans. It is also likely to qualify you for better interest rates.
Why is DTI important?
Your debt-to-equity ratio is one of the most important factors lenders look at when evaluating your creditworthiness. Your debt-to-equity ratio, credit score, and credit history provide a picture of your financial health that lenders use when deciding whether to accept or reject your loan applications. From a lender’s perspective, the higher your debt-to-equity ratio, the more risk they would take. Essentially, having a low debt-to-equity ratio, especially if you also have a high credit score, proves to lenders that you are likely to pay your debts.
While almost all types of lenders consider your debt-to-equity ratio when assessing a borrower’s creditworthiness, different types of lenders have different requirements. Here are some of the types of loans that take into account your debt ratio:
- Car credits: Auto lenders generally require a debt to income ratio of 45-50% or less.
- Personal loans: Personal lenders generally require a debt-to-income ratio of 40% or less.
- Home Equity Loans: Home equity loans and home equity lines of credit generally require a debt to equity ratio of 47% or less.
- Mortgages: Mortgage lenders generally require a debt-to-income ratio of 43% or less.
Here’s a breakdown of how different DTI ratios affect your ability to take out a new loan:
|DTI report range||What this means|
|DTI||Your debt is manageable and you should have no problem getting a loan|
|TDI 36% – 42%||Some concerns of lenders. You may want to consider paying off a debt|
|DTI 43% – 50%||You may be denied and find it difficult to repay the debt you have|
|TDI > 50%||Debt repayment will be the hardest and borrowing options are limited|
What should I do if my DTI ratio is bad?
If your debt ratio isn’t what you want it to be, you’re not alone. Data from the Federal Reserve indicates that total household debt in the United States increased by $266 billion in the first quarter of 2022. Despite this, the rate of transition from debt to delinquency remained historically low. This means that even though people are taking on more debt, they are generally repaying their creditors. Nevertheless, this increase in overall debt indicates that many Americans are likely struggling with a high debt-to-income ratio.
There are several things you can do to improve your debt-to-income ratio. Here are some strategies that might help you improve your DTI ratio:
- Repay existing debt: If you are financially able to do so, increasing your monthly payments will decrease your overall debt more quickly and improve your DTI. For example, if you’re only making the minimum payments on a credit card or personal loan, consider paying a little more per month to reduce your debt faster.
- Postpone large purchases: If your debt-to-income ratio is higher than you would like, you may want to consider pausing the use of your available credit to make large purchases or apply for additional loans.
- Create and stick to a budget: Having a personal monthly budget is a great way to reduce your overall expenses so you can increase monthly debt payments and get out of debt faster. To start, it’s a good idea to track your spending habits and make a list of necessary expenses.
- Regularly check your DTI ratio: Your DTI ratio changes as you repay and/or incur debt. Try recalculating your DTI every month to track your progress.
If you’re struggling to manage your debt, it may be a good idea to consider options such as credit counseling, debt consolidation, and debt relief. Although there are lenders who cater to borrowers with bad credit and high debt-to-equity ratios, it’s worth considering whether or not it’s possible to take out a new loan if you’re already in debt. Unless you need emergency financing, you should work to pay off your current debt before taking on more.
There is the possibility of consolidating your debts with a debt consolidation loan. Although unsecured debt consolidation loans tend to have stricter DTI requirements than other loans, it’s a great option if you can apply with a co-signer. You can also consider a credit card balance transfer to consolidate your debt. Many credit card lenders offer low-to-no interest introductory periods for borrowers who transfer their card balance. Consolidating all your debts into one monthly payment and lowering your interest rate is likely to lower your DTI.
The bottom line
Your debt-to-equity ratio, along with your credit score, is the primary method a lender uses to assess your creditworthiness and ability to repay a loan. It is extremely important to prove reliability to lenders when applying for unsecured loans. Not only does your DTI impact your ability to qualify for a loan, it also impacts the interest rate you will qualify for. If you’re looking to take out a home improvement loan, for example, it’s important to know your DTI ratio to determine what you’ll qualify for and whether or not you can afford the new loan.
If your debt ratio is preventing you from making financial moves, consider reducing it to improve your overall financial health.