Calculate Your DTI Ratio
Understanding Debt-to-Income (DTI) Ratio
Your Debt-to-Income (DTI) ratio is one of the most critical metrics lenders use to assess your ability to manage monthly payments and repay debts. It compares how much you owe each month to how much you earn. Unlike your credit score, which measures your history of repayment, DTI measures your current financial capacity.
Why DTI Matters for Mortgages and Loans
When you apply for a mortgage, personal loan, or auto financing, the lender wants to ensure you aren't overextended. A lower DTI ratio demonstrates a good balance between debt and income. Most lenders have strict thresholds:
- 35% or less: Generally viewed as favorable. You have manageable debt relative to your income.
- 36% to 49%: You may still qualify for loans, but lenders might ask for additional conditions or offer higher interest rates.
- 50% or higher: Considered high risk. You may have difficulty qualifying for a mortgage or other significant financing.
Front-End vs. Back-End DTI
There are technically two types of DTI ratios that mortgage lenders look at:
1. Front-End Ratio: This only includes your housing expenses (mortgage principal, interest, taxes, and insurance) divided by your gross monthly income. Ideally, this should be under 28%.
2. Back-End Ratio: This is what the calculator above computes. It includes housing expenses plus all other recurring monthly debts like credit cards, car loans, and student loans. Ideally, this should be under 36% for the best loan terms, though many conventional loans allow up to 43-45%.
How to Lower Your DTI Ratio
If your calculation shows a percentage higher than 43%, consider these strategies before applying for a major loan:
- Pay down high-interest debt: Reducing credit card balances lowers your monthly minimum payments.
- Increase your income: Taking on a side gig or negotiating a raise increases the denominator in the calculation, lowering the ratio.
- Avoid new debt: Do not open new credit lines or finance large purchases before a mortgage application.
Example Calculation
Let's say you earn $6,000 per month in gross income. You have a rent payment of $1,500, a car payment of $400, and student loans totaling $200.
Total Monthly Debt = $1,500 + $400 + $200 = $2,100.
DTI Formula: ($2,100 / $6,000) x 100 = 35%.
This falls into the "Good" category, making you an attractive candidate for lenders.