What is a Debt-to-Income (DTI) Ratio?
Your Debt-to-Income (DTI) ratio is a critical financial metric that compares an individual's total monthly debt payments to their gross monthly income. Lenders use this percentage to assess your ability to manage monthly payments and repay debts. It is one of the primary factors considered when applying for mortgages, auto loans, and personal lines of credit.
Essentially, the DTI ratio answers the question: "How much of this person's income is already spoken for by existing debt?" A lower ratio indicates a healthy balance between debt and income, while a higher ratio suggests financial strain.
How to Calculate Your DTI
To calculate your DTI manually, you follow a simple formula:
- Step 1: Add up all your recurring monthly debt payments (rent/mortgage, student loans, auto loans, credit card minimums, child support, etc.).
- Step 2: Determine your gross monthly income (your income before taxes and deductions).
- Step 3: Divide your total monthly debt by your gross monthly income.
- Step 4: Multiply the result by 100 to get a percentage.
For example, if your total monthly debt is $2,000 and your gross monthly income is $6,000, your calculation would be: ($2,000 / $6,000) = 0.333, which is a 33.3% DTI.
Interpreting Your Results: What is a Good DTI?
While lender requirements vary, general guidelines for interpreting your DTI ratio include:
35% or Less: Excellent
This is considered the ideal range. It shows lenders that you have manageable debt relative to your income. You likely have money left over for savings and unexpected expenses. You are in a prime position to get approved for new credit at favorable interest rates.
36% to 43%: Good / Manageable
Most lenders, particularly for Qualified Mortgages, prefer a DTI ratio no higher than 43%. In this range, you are still seen as a reasonable risk, but you might have less flexibility in your monthly budget. You can usually get approved for loans, though perhaps not always at the absolute lowest tier of interest rates.
44% to 49%: At Risk
If your DTI falls in this bracket, you may face difficulties obtaining a mortgage or other significant loans. Lenders worry that adding another payment to your budget will cause you to default. You may be required to pay down debt before being approved.
50% or Higher: High Risk
With half or more of your gross income going toward debt, you have very little room for living expenses and taxes. Most lenders will decline loan applications in this range. It is highly recommended to focus on debt consolidation or aggressive repayment strategies to lower this number.
Front-End vs. Back-End DTI
It is important to note that there are two types of DTI ratios often discussed in mortgage lending:
- Front-End Ratio: This only calculates housing-related expenses (mortgage principal, interest, taxes, insurance, and HOA fees) divided by gross income. Lenders typically prefer this to be under 28%.
- Back-End Ratio: This is what our calculator above computes. It includes housing expenses plus all other consumer debt (credit cards, student loans, cars). Lenders typically prefer this to be under 36-43%.
Tips to Lower Your DTI Ratio
If your calculation shows a high percentage, consider these strategies:
- Increase Income: Taking on a side gig, asking for a raise, or including a co-borrower on a loan application can increase the denominator in the calculation, lowering the ratio.
- Pay Off Small Debts: Eliminate credit cards or small loans entirely to remove that monthly payment obligation from the equation.
- Avoid New Debt: Do not open new credit lines or finance large purchases before applying for a major loan like a mortgage.