How to Use (and Calculate) Debt-to-Income Ratio

Your debt-to-income ratio or DTI represents the amount of your income that goes to debt repayment each month. So why does that matter? For one thing, debt to income can be an important factor in determining whether you qualify for certain loans. If you’re trying to buy a home, for instance, lenders will calculate your DTI when determining mortgage approval. For another, a lower debt-to-income ratio means you may have more money to save and invest for the future. If you’re not sure how much of your income goes to debt each month, here’s how to calculate it.

A financial advisor could help you create and execute a financial plan for long-term goals such as purchasing a home or retiring early.

Debt-to-Income Ratio Definition

Debt-to-income ratio measures how much of your income goes to debts each month. Lenders use your DTI ratio to gauge your ability or means to pay back money that you borrow. For instance, a higher debt-to-income ratio could suggest that you may have more trouble repaying loans or lines of credit.

Your DTI isn’t the only thing lenders look at when making lending decisions. They can also consider your credit history and credit scores and assets. But debt-to-income ratio can indicate how much risk the lender may be taking on when granting you a loan or line of credit.

How to Calculate Debt-to-Income Ratio

Figuring out your DTI is a fairly simple process if you know how to do it. Here’s how to calculate the debt-to-income ratio:

• Total monthly debt payments ÷ Gross monthly income × 100 = Debt-to-income ratio

In this formula, total monthly debt payments represent the total amount combined you pay to debt each month. So this includes payments to student loans, credit cards, car loans, personal loans, mortgages or any other debts you have. Lenders generally use required monthly payments rather than your total outstanding loan balances. For credit cards, this typically means the minimum required payment, not the amount you choose to pay above that minimum.

Your gross monthly income is your income before taxes and other deductions are taken out. This is your total income from all sources, including a 9 to 5 job, a part-time job or second job, a side hustle and any payments you receive in the form of government benefits, child support or alimony. However, lenders may require documentation and apply specific rules before counting income from sources such as self-employment, benefits, child support, or alimony.

Debt-To-Income Ratio Example

First, add up all of your monthly debt payments. Remember, you’re only looking at debts here, not other expenses such as utility bills or insurance. For a mortgage application, the calculation generally includes the proposed housing payment, including applicable property taxes, homeowners insurance and association dues.

Next, add up your gross monthly income. If you work a regular 9 to 5 you can find your gross pay listed on your pay stubs. If you’re self-employed or do gig work, you may need to check your bank statements to see how much you’ve deposited. Lenders may calculate qualifying self-employment income from tax returns and other financial records rather than using deposits alone.

Now, say you have total debt payments of $1,500 each month. Meanwhile, your total gross monthly income is $5,000. To find your DTI, you’d divide $1,500 by $5,000 to get 0.3. You’d then multiply that by 100 to get your final debt-to-income ratio of 30%.

That means 30% of your gross income goes to debt repayment each month. Which brings us to the next question: What is a good debt-to-income ratio?

What Debt-to-Income Ratio Means for Borrowing

When you’re applying for loans, lenders want some reassurance you can repay it. Generally speaking, a debt to income ratio in the 40% to 50% range could suggest to lenders that you have a significant debt burden. And it’s possible that if you’re in this range, you may have trouble qualifying for certain loans. If you want to get approved for a qualified mortgage, for example, the maximum acceptable DTI is typically 43%. But lenders often look for a debt-to-income ratio of 36% or less.

If you want to get approved for a qualified mortgage, there is no longer a universal 43% DTI limit for the general qualified mortgage category. The Consumer Financial Protection Bureau removed that requirement and replaced it with pricing-based criteria. Individual mortgage programs still have their own DTI requirements. For example, Fannie Mae generally allows a maximum DTI of 36% for manually underwritten loans, potentially increasing to 45% for borrowers meeting additional requirements. Loans evaluated through its Desktop Underwriter system may qualify with a DTI as high as 50%. ¹

So again, what is a good debt-to-income ratio? The simple answer is that lower is better. A lower DTI makes it easier to get approved for loans or lines of credit. Having less of your income going to debt each month could also help you to secure loans at lower interest rates.

It’s also important to keep in mind that debt-to-income ratios don’t account for other money you spend. For example, it doesn’t factor in what you spend on utilities, food, transportation or insurance. If you live in a more expensive city, then a good chunk of your income may be going to those things already. Even if you have a low DTI on paper, other expenses can still impact your ability to afford a loan.

How Much Debt Can You Have at Different DTI Ratios?

Your DTI can help you estimate how much room you have for another monthly loan payment. The calculation starts with your gross monthly income, then applies a target DTI percentage to find the total debt payments that would fit within that percentage.

Suppose you earn $6,000 a month before taxes and already have $1,500 in required monthly debt payments. Your current DTI is 25%, calculated by dividing $1,500 by $6,000. The table shows how much additional monthly debt payment would bring your DTI to several possible levels.

For instance, a target DTI of 36% allows $2,160 in total monthly debt payments. Subtracting the existing $1,500 leaves $660 for a potential new payment.

These figures are calculations, not lending approvals. A mortgage lender may count property taxes, insurance and other housing costs when determining the proposed payment. It may also use a different qualifying income figure or apply a lower DTI ceiling based on the loan program.

How to Improve Your Debt-to-Income Ratio

Improving your DTI comes down to doing one of two things (or both): Increasing your income or reducing your debt.

On the income side, there are some things you can do try to raise your gross pay. The options include:

• Negotiating a raise at work
• Taking a second job or part-time job
• Starting one or more side hustles

You can also generate income through investments. For example, investing in dividend-paying stocks could help you to create a passive income stream. Real estate can also provide passive income if you’re earning dividends from a real estate investment trust (REIT). Investing in rental property can also provide monthly income but it can be more hands-on than owning REITs or real estate ETFs in your portfolio. Keep in mind that lenders may not count every source of investment income toward qualifying income.

If you’re interested in reducing debt, you could start by making it more affordable. Refinancing a mortgage or student loans or consolidating high-interest credit card debt, for example, could allow you to pay more toward the principal each month and less in interest. That could help you to pay back what you owe at a faster pace. However, refinancing or consolidation does not automatically lower your DTI. The ratio improves only if the required monthly debt payments decrease relative to qualifying income, or qualifying income increases.

A positive side effect of reducing your debt is that it may also raise your credit score. That can be a win-win if you’re hoping to get approved for a mortgage or another loan and you’re angling for the best interest rates.

Bottom Line

Debt-to-income ratio is an important measure of financial health. Lenders can use your DTI to gauge your ability to repay loans when you borrow and the lower your ratio is, the better for getting approved at low rates. Finding ways to grow your income, through working or investing, while paying down debt can help with improving your debt-to-income ratio.

Financial Planning Tips

• Consider talking to a financial advisor about your debt-to-income ratio and what it means from a financial planning perspective. SmartAsset’s free tool matches you with financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Use a free personal loan calculator as you take stock of your debt-to-income ratio.
• If you’re struggling with debt repayment, you may consider seeking help from a nonprofit credit counselor or financial advisor debt counselor. Debt and credit counseling can help you to analyze your spending and create a realistic budget so you can pay off your debts. Or a credit counselor may recommend a structured debt management plan (DMP) for getting out of debt.

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