Debt to Income Ratio (DTI)

What is Debt-to-Income?

The debt-to-income ratio is the percentage of a person’s monthly gross income used to pay debts. Generally, the higher the ratio, the higher the perceived risk. Loans with higher risk are generally priced at a higher interest rate.

Why It’s Important

In other words, it is the amount of debt compared to your overall income. Lenders use this ratio when determining whether to lend you money. A low debt-to-income ratio is more desirable.

Do you know how much debt you hold? If you’re holding too much debt in relation to your income, it can be a sign of future financial troubles.

How to Calculate Your Debt-to-Income Ratio

Knowing your DTI can help you understand the potential risk you’re taking when applying for a new loan. Keeping your debt at a manageable level is one of the foundations of financial well-being.

Step 1: Determine Monthly Debt Payments

List your debts and add up all your monthly debt payments. This includes mortgage payments, rent, car loans, student loans, personal loans, minimum credit card payments, alimony, child support, and other recurring debt obligations.

Step 2: Calculate Gross Monthly Income

Add up all your gross monthly income sources. This includes salaries, wages, bonuses, tips, commissions, rental income, alimony, child support, investment income, and other regular income sources.

Step 3: Divide Total Monthly Debt Payments by Gross Monthly Income

Use the DTI Ratio Formula. Divide your total monthly debt payments by your gross monthly income.

Example Calculation

If your total monthly debt payments amount to $2,000 and your gross monthly income is $6,000, your DTI ratio would be calculated as follows:

  • DTI Ratio = (Total Monthly Debt Payments / Gross Monthly Income) * 100
  • DTI Ratio = ($2,000 / $6,000) * 100
  • DTI Ratio = 0.333 * 100
  • DTI Ratio = 33.33%
Description Amount ($)
Total Monthly Debt Payments $2,000
Gross Monthly Income $6,000
Debt-to-Income (DTI) Ratio 33.33%

Step 4: Interpret the Result

Your DTI ratio represents the percentage of your gross monthly income that goes towards paying off debt. The lower your DTI ratio, the lower your debt burden relative to your income, which is generally considered favorable. Lenders typically use DTI ratios to assess borrower’s ability to manage additional debt responsibly.

Here’s a table illustrating different debt-to-income (DTI) ratio ranges. It briefly what being in a range might mean.

Debt-to-Income Ratio Range Interpretation
Less than 20% Low debt burden, favorable
20% – 35% Moderate debt burden, manageable
36% – 49% High debt burden, potential risk
50% or higher Very high debt burden, high risk

Additional Tips

  • Include Minimum Payments: Ensure that all debts are included, even if you pay more than the minimum each month.
  • Use Gross Income: When calculating DTI, use your gross income (before taxes and deductions) rather than your net income (after taxes and deductions).
  • Keep Track Regularly: Monitor your DTI ratio regularly to assess your financial health and make informed decisions about managing debt and achieving your financial goals.

Calculating your DTI ratio can help you gain insight into your overall debt load relative to your income and make informed decisions about managing debt and improving your financial well-being.

How to Lower Your DTI

Here are some creative ways to lower your debt-to-income ratio.

Pay off debt

Paying off debt is the fastest way to lower your debt-to-income ratio. Once the debt is paid off, you no longer have the minimum monthly payment.

Ask for a pay raise

Increase your income. A small salary increase can lower your debt-to-income ratio. Set a time and date to discuss your salary with your manager. Here’s a tip: Determine how much more you need to make to get your DTI at a desirable level. You can use that number to help you figure out how much to ask for.

Make extra income

Get a side hustle. Money earned from freelancing or through side hustle apps can be added to your income.

Pay down credit card balances

Do what you can to lower the balances, which will lower the minimum monthly payments along the way. Consider selling unused items around the home to get some extra cash to do this.

Negotiate for a lower interest rate

Sometimes there’s a catch-22. You want to apply for a consolidation loan but can’t get approved because your DTI is too high. Unfortunately, some lenders will use your current ratio and not factor in the change after a consolidation. So, you’ll need to negotiate with your credit card companies and lenders instead. If you’re successful, a lower APR can mean lower payments.

Consolidate your credit cards

Consider consolidating multiple credit cards if you’re in a good financial situation. A consolidation loan may have a lower APR and reduce monthly payment amounts.

Transfer credit card balances

A 0% balance transfer promotional card means you can pay off your balances faster. Since the APR is zero for a period of months, your payments will go directly to the principal balance.

Refinance existing loans

By refinancing, you can potentially get a lower rate and better terms, lowering your monthly debt payments. List all debts and contact the lenders. Ask them what options are available. For example, you might be able to refinance student loans, thus lowering your payments.

Reduce your expenses

If you want to lower your debt-to-income ratio, cut back spending and use the money for debt repayment. The more money you can put towards debt, the faster you can improve your DTI ratio.

In summary, you want and should lower your debt-to-income ratio to improve your financial security. The less debt you hold, the better you’ll feel. Knowing and tracking your DTI can help you adjust your financial plan to meet your goals.