How to calculate your debt-to-income ratio

If you’ve ever been concerned that you have too much debt, calculating your debt-to-income (DTI) ratio is a quick way to assess your current debt burden by understanding how much of your monthly income goes toward debt payments. If you want to borrow money in the future to buy a home or make another large purchase, lenders may assess your DTI ratio alongside other factors when they make the lending decision. Having a lower DTI ratio is typically associated with being able to receive more favorable loan terms like a larger loan amount and lower interest rates.

Here’s what we’re going to cover:

• What is a debt-to-income ratio?
• Types of debt-to-income ratios
• How to calculate your debt-to-income ratio
• Debt-to-income ratio example
• What is a good debt-to-income ratio?
• How to lower your DTI ratio
• Oportun: Affordable lending options designed with you in mind

What is a debt-to-income ratio?

Your debt-to-income (DTI) ratio shows how much of your monthly income goes toward paying off debt. When you apply for certain loans, like a mortgage or personal loan, the lender may assess your DTI ratio to determine whether you can afford to take on new debt. Lenders may only make a loan if they think the applicant can repay the loan.

Types of debt-to-income ratios

There are two ways to calculate your DTI ratio:

Front-end DTI

Your front-end DTI ratio only considers your housing debt payments, so the percentage is often much lower than back-end DTI. Housing payments include mortgage payments, property taxes, homeowners insurance, and HOA fees. Rent would not be included if those payments would be replaced with a mortgage.

The front-end ratio is generally used by mortgage lenders since it considers only housing costs.

Back-end DTI

The back-end DTI ratio considers all your monthly debts, including installment loans like a personal loan, credit card payments, student loan payments, child support payments, and more. Since the back-end metric looks at all debt, it’s typically a higher number than the front-end DTI ratio and tends to be the number lenders use when making a lending decision.

How to calculate your debt-to-income ratio

You can quickly calculate your debt-to-income ratio by following the below steps:

1. Gather your total monthly debt payments. Be sure to include debts such as credit cards, student loans, child support, and housing costs.
2. Calculate your gross monthly income. A DTI ratio uses the gross value, which is the money you earn before taxes and other deductions (compared to net monthly income, which is the amount you see in your paycheck). You may need to pull out your latest pay stub to confirm your gross monthly income. Then, be sure to add in money you make from any part-time work or side gigs.
3. Divide your debt by your gross income. For example, if debt payments are $1,000 and gross income is $2,000, calculate $1,000/$2,000, which is .5. Then, move the decimal over to the right twice to get the DTI ratio of 50%. Said another way, half of this person’s income is spent on debt payments.

Debt-to-income ratio example

Let’s step through an example of a debt-to-income ratio calculation. Say you have monthly debt payments of $1,600, which consist of the following expenses:

Monthly debt payments: $1,600

• $550 – Car loan
• $250 – Student loans
• $500 – Credit cards
• $300 – Personal loan

Between your full-time job and your weekend side hustling, you bring in $4,800 each month.

Gross monthly income: $4,800

• $4,000 – Based on a salary of $48,000/year
• $800 – Driving for rideshare on weekends

When you divide your debt payments by your gross monthly income, you’ll get a DTI ratio of 33%.

$1,600/$4,800 = .33 = 33%

Your next logical question is likely, is that DTI ratio any good? Understanding how lenders view a potential borrower’s DTI ratio can help.

What is a good debt-to-income ratio?

Typically, lenders will assess debt-to-income ratios as good or bad depending on how high the percentage is. The following ranges can be used as a rule of thumb, but the maximum DTI ratio a lender will accept varies. So, you can check your specific lender’s requirements before you count yourself out to qualify for a loan.

• DTI ratio less than 35%: Any DTI ratio below 35% is typically considered good and will be viewed favorably by lenders. In this range, you stand a better chance of qualifying for loans, assuming other qualifications are in order.
• DTI ratio between 36% and 49%: A DTI ratio in this range means that your debt payments take up almost half of your take-home pay, which may indicate to lenders that you’d struggle to afford another loan. However, you still may qualify if you’re in the lower end of this range.
• DTI over 50%: A high DTI ratio where you’re putting more than half of your money toward debt is a red flag to lenders who will be skeptical of your ability to handle more debt. If you fall into this bucket, consider lowering your DTI ratio before applying for any new debt.

How to lower your DTI ratio

There are two straightforward ways to lower your DTI ratio:

1. Pay off your existing debt: The first way to lower your DTI ratio is by keeping your income the same and decreasing the amount of debt you owe every month by paying it off. If you have a lump sum of money set aside or receive a sudden windfall, you could quickly make a dent in a large debt balance. For example, if you currently put $1,500 toward debt with an income of $3,500 per month, your DTI ratio is 42.8%. If you can make a lump sum payment on your debt that cuts the monthly amount due in half to $750, you’d decrease your DTI ratio to a much lower 21.4%.
2. Increase your monthly income: On the other side of the equation, you can earn more income to lower your DTI ratio. If you’re paying $2,000 each month toward debt at an income of $4,000, your DTI ratio is 50%. However, if you’re able to earn $1,000 more by picking up a side hustle, your DTI ratio will instantly drop to 40%.

Oportun: Affordable lending options designed with you in mind

Now that you understand how your debt-to-income ratio works, you can learn about how Oportun may be able to help you if you’re looking for affordable credit options. Visit our homepage to learn about:

• Personal loans
• Credit cards
• Secured personal loans
• And more!

Sources

Bankrate. Debt-to-income ratio calculator

Investopedia. Debt-to-Income (DTI) Ratio: What’s Good and How to Calculate It