How to calculate debt-to-income ratio and why it’s important

What is debt-to-income ratio?

In simple term, your debt-to-income ratio (DTI) compares the amount of money you owe—your debt—to the amount of money you earn—income—on a monthly basis. The amount of money you owe, or your debt, includes any monthly payments you make such as rent or mortgage payments, credit card payments, and student loan payments. DTI is calculated as a percentage and is a number that lenders will use when considering you for lines of credit and loans. Your DTI helps demonstrate your ability to repay what you’re borrowing.

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How to calculate DTI in three steps

Calculating your debt-to-income ratio is simple: all you need to do is add up your monthly payments and divide them by your monthly income. Follow the steps below to get started:

Step 1: total your debts

Add up all your monthly debt payments and bills, including rent or mortgages, student loan payments, car loan payments, credit card payments, alimony or child support, and any additional debts you’re working to pay off. Utilities like gas and electric bills and monthly expenses such as groceries are not typically included in DTI calculation.

Step 2: calculate your income

Calculate your gross monthly income, which is how much money you earn every month before taxes are taken out.

Step 3: divide for your ratio

Divide the number you calculated in Step 1 by the number you calculated in Step 2. This number is your debt-to-income ratio and can be read as a percentage.

Interpreting your debt-to-income ratio

While DTI limits may vary from lender to lender, 43% is generally what’s considered to be a good DTI. 43% is the maximum DTI that allows you to apply for a Qualified Mortgage—anything lower and you’re starting to get into risky territory.

In general, the lower your DTI, the better your application looks to lenders. However, if you’re just starting your money management journey, you might be looking at a higher number at first. A debt-to-income ratio of 50% or more indicates to lenders that you might have difficulty meeting your monthly payments: you may need to increase your income or decrease your debt before you can receive additional loans. A DTI that falls between 42% and 49% means that you’re getting close to the red zone and may hurt your loan or credit application. The 36% to 41% DTI range shows lenders that you have a manageable level of debt and you’re likely a good candidate for loans. However, you may still be excluded from bigger loans or loans with strict qualifiers. If your DTI is 36% or less, you’re in great standing—you have a high amount of income relative to your debts and lenders will likely consider you to be a safe candidate for new loans.

Does your DTI impact your credit score?

Although debt-to-income ratio and credit score are two factors that most lenders consider when evaluating your eligibility for loans or credit, your credit score is separate from your DTI. Because credit reporting agencies do not use a person’s income to calculate credit score, your DTI does not impact your credit report: credit reporting agencies focus on your debts rather than your income.

Why DTI is important

Maintaining a low debt-to-income ratio is an important indicator of your financial health. Having a DTI within a certain range demonstrates to lenders that you’re able to both manage money and pay off the money you owe, which improves your chances of eligibility for various services. A good DTI isn’t just for credit lenders, though—understanding your own debt-to-income ratio can help you weigh the risk of personal financial decisions. When your DTI starts exceeding 43%, you’re impacted in several ways, including less room in your budget, less favorable terms when you take out credit, and limits on home loan qualification.

Ready to take control of your finances? Calculating your DTI and working on improving it is a great place to start.