Lenders use many variables when deciding whether or not to loan you money, from your credit score and history to your annual income. One of those variables in determining financial health is called a debt-to-income ratio, which is a simple equation that results in a single percentage: your DTI. The number reveals how much debt you owe compared with the income you earn.
A high debt paired with a low income will result in a high percentage. The reverse also is true: A relatively high income and low debt will yield a smaller number, which is optimal when applying for a loan.
What Is a Debt-to-Income Ratio?
Your DTI ratio is your minimum monthly debt payments divided by your gross monthly income. Recurring debt — expenses that fall under monthly debt — includes any type of loan. It also refers to financial obligations that you can’t easily cut back on like you could with an entertainment budget, for example.
Recurring debt includes:
- Mortgage payments or rent
- Credit card payments
- Auto loan payments
- Child support
Why Do I Need to Know My Debt-to-Income Ratio?
Lenders view the debt-to-income ratio, which is expressed as a percentage, as a good predictor of a person’s ability to manage the monthly payments on the loan they might or might not give you.
Another reason it’s wise to know your DTI is so that you can lower it, if necessary, before it’s time to buy a house or apply for another type of loan. You can lower your DTI by earning more money, lowering your debt or doing both.
What Is a Good Debt-to-Income Ratio?
Generally, a DTI that’s less than 43 percent is a good number to aim for. The 43 percent DTI is the highest ratio a borrower can have and still get approved for a mortgage, according to the Consumer Financial Protection Bureau.
However, a DTI that’s higher than 43 percent ratio might not be a deal breaker. Although small lenders — those with under $2 billion in assets — must consider your DTI, they’re allowed to approve qualified mortgages with DTI scores higher than 43 percent. Bigger lenders, on the other hand, are required by the Consumer Financial Protection Bureau to ensure that borrowers with a score above 43 percent can, in fact, repay the loan.
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.
You can use the following DTI calculatorto quickly find your DTI: