- Glossary
- What Is Gross Monthly Income?
- What Is Management?
- What Is A Problem Statement?
- What Is Annual Net Income?
- What Is A Letter Of Transmittal?
- What Is Attrition?
- What Does White Collar Mean?
- What Does Blue Collar Mean?
- What Is Efficiency Vs Effectiveness?
- What Is A Dislocated Worker?
- What Is Human Resource (HR)?
- Thank You Letter Scholarships
- What Is Constructive Criticism?
- What Is A Quarter Life Crisis?
- What Is Imposter Syndrome?
- What Is Notes Payable?
- Types Of Communication
- Economic Demand
- Cost Benefit Analysis
- Collective Bargaining
- Key Performance Indicators
- What Is Gender Bias In A Job Description?
- What Is The Hidden Job Market?
- What Is The Difference Between A Job Vs. A Career?
- What Is A Prorated Salary?
- W9 Vs. 1099
- Double Declining Balance Method
- Divergent Vs Convergent Thinking
- Budgeting Process
- Types Of Intelligence
- What Is Bargaining Power?
- What Is Operating Capital?
- Difference Between Margin Vs Markup
- Participative Leadership
- Autocratic Leadership
- Authoratarian Leadership
- Situational Leadership
- Difference Between Generalist Vs Specialist
- Strategic Leadership
- Competitive Strategies
- Equity Vs Equality
- What Is Marginalization?
- Colleague Vs Coworker
- What Is The Glass Ceiling?
- What Are Guilty Pleasures?
- Emotion Wheel
- Nepotism In The Workplace
- Sustainable Competitive Advantage
- Organizational Development
- Communication Styles
- Contingent Workers
- Passive Vs Non Passive Income
- Choose A Career
- Formulas
- APR Formula
- Total Variable Cost Formula
- How to Calculate Probability
- How To Find A Percentile
- How To Calculate Weighted Average
- What Is The Sample Mean?
- Hot To Calculate Growth Rate
- Hot To Calculate Inflation Rate
- How To Calculate Marginal Utility
- How To Average Percentages
- Calculate Debt To Asset Ratio
- How To Calculate Percent Yield
- Fixed Cost Formula
- How To Calculate Interest
- How To Calculate Earnings Per Share
- How To Calculate Retained Earnings
- How To Calculate Adjusted Gross Income
- How To Calculate Consumer Price Index
- How To Calculate Cost Of Goods Sold
- How To Calculate Correlation
- How To Calculate Confidence Interval
- How To Calculate Consumer Surplus
- How To Calculate Debt To Income Ratio
- How To Calculate Depreciation
- How To Calculate Elasticity Of Demand
- How To Calculate Equity
- How To Calculate Full Time Equivalent
- How To Calculate Gross Profit Percentage
- How To Calculate Margin Of Error
- How To Calculate Opportunity Cost
- How To Calculate Operating Cash Flow
- How To Calculate Operating Income
- How To Calculate Odds
- How To Calculate Percent Change
- How To Calculate Z Score
- Cost Of Capital Formula
- How To Calculate Time And A Half
- Types Of Variables
Find a Job You Really Want In
Whether you’re gearing up to buy a new car or looking for that perfect starter home, your debt-to-income ratio (DTI) will have an impact on what you can purchase and when you can purchase it. Simply put, your DTI is the percentage of your gross monthly income dedicated to paying off debts, and it matters in the eyes of potential lenders.
In the case of making large purchases that require financing, your DTI is important because banks will use it to gauge whether or not they want to loan to you. Generally speaking, banks use your DTI to estimate the monthly payments you’ll be able to handle, as well as how likely you are to pay them back.
Luckily, you can calculate your DTI on your own, which will allow you to predict which loans you could be approved for. After all, the more you know about your financial situation, the easier it will be to make decisions about your income that will further your goals.
With that in mind, this article will examine how to properly calculate and manage your DTI, as well as explain the subtle nuances of the system.
A Detailed Look at Debt-to-Income Ratio
Like many other financial measurements, the debt-to-income ratio is all about balance. More specifically, having a low DTI represents a good balance between your personal debt and income, as the lower your DTI, the less money you’re typically spending on your debts each month.
As such, your DTI ratio is represented as a percentage to show the portion of your average income spent on debts. For example, if your DTI ratio was 23%, that number would indicate that you dedicate 23% of your gross income to debt payments each month.
Ideally, you’ll want your DTI ratio to be as low as possible. After all, a high DTI of 60% would leave you little income to spend on groceries, events, or hobbies. In fact, a high DTI ratio is a huge red flag for investors and lenders, as the percentage will suggest that a borrower cannot handle taking on any more loans.
As a result, it’s no surprise that the debt-to-income ratio will usually affect what borrowers can finance as banks and other lenders will analyze it before deciding to lend money.
How Banks Assess Debt-to-Income Ratio
To understand how likely you’ll be to receive a loan, it’s important to know how exactly banks choose to evaluate your debt-to-income ratio. Typically, banks and other lenders will want your debts to account for no higher than 36% of your monthly income.
While there can be leeway of up to 5%, the lower the DTI, the better. Banks stick to these numbers to ensure that borrowers will have enough income remaining to handle the extra expense of a new loan.
Banks also value a low DTI because it’s an important piece of your financial puzzle. For instance, a high DTI might correlate with a low credit score caused by late payments. After all, it can be difficult to make payments on time if a borrower doesn’t have the monthly funds to consistently cover all of their debts.
In this way, banks choose to assess your DTI ratio when you submit a loan application because they want to ensure that you can pay your debts efficiently and consistently.
Remember, though, that not all lenders are the same. For example, if you were looking to buy a house, an unconventional loan such as an FHA loan may accept a higher DTI ratio. Often, unconventional loans may come with additional expenses or restrictions but are still options nonetheless.
The Debts Included in Your DTI Ratio
Knowing what kind of debts are included in a DTI ratio can help you understand how a bank will calculate your DTI ratio, as well as allow you to calculate your own. Some of the most common recurring debts include:
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Rent or Mortgages
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Auto Loans
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Student Loans
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Child Support Payments
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Alimony Payments
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Minimum Credit Card Payments
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Personal Loans
Generally speaking, your DTI ratio does not include utility bills or necessities such as food and gas. Therefore, if you’re looking to acquire a new loan, it’s important that you not only analyze your DTI but also account for any extra expenses you have each month. Even if lenders won’t inspect these extra costs, it’s certainly in your best interest to know exactly what you can afford.
How To Calculate Your DTI Ratio
For the most part, calculating your DTI ratio is actually rather simple. First, gather information using the following steps:
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Add up your monthly debt payments to determine your total monthly debt.
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Determine your total monthly income before taxes.
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Divide your total monthly debt payment by your gross monthly income.
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If your income is higher than your debt, you will yield a decimal
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Multiply the decimal by 100 to discover your DTI percentage.
The equation is as follows:
Total Monthly Debt Payments ÷ Gross Monthly Income = Total DTI
If you find that your debt-to-income ratio is above 50%, you might need to pay off some of your previous loans before you can consider a new purchase. While on the other hand, if your DTI ratio is below 30%, you may find that you can be approved for a larger loan than you expected.
Either way, always be aware of your most up-to-date DTI status, as the information will allow you to make more thoughtful financial decisions.
Debt-to-Income Ratio Example
To picture the importance of DTI in a realistic context, imagine the following scenario:
Thomas is interested in financing his first house and wants to know his DTI ratio before he files a loan application. These are Thomas’ current monthly debt payments:
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Auto Loan: $250
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Credit Card Payments: $60
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Student Loans: $300
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Personal Loans: $100
Thomas’ Total Monthly Debt Payments: $710
Now that we know Thomas’s total monthly debt payments, we can address his total monthly income. Let’s say he makes $2,200 per month. Now we can apply these numbers to our formula:
$710 ÷ $2,200 = 0.32
Now we simply multiply 0.32 by 100 to achieve a 32%. In total, this means that Thomas’ DTI ratio is precisely 32%.
Tips for Improving Your DTI
Overall, there are two ways in which you can effectively lower your debt-to-income ratio. You can either lessen your monthly recurring debt or find ways to increase your gross monthly income. Of course, there’s nothing stopping you from doing both, but you should assess your current situation to see what might work best for you.
For example, if James is looking to buy a new car but wants to lower his current DTI ratio of 40% first, he has a few options. For context, his monthly gross income is $4,000, and his monthly debt payments total at around $1,600.
In one case, James might want to apply for more part-time work, which would increase his monthly gross income to $5,500. Doing so would effectively lower his DTI to 29% ($1,600 ÷ $5,500 = 0.29).
On the other hand, if James doesn’t have the ability to work more hours or find a higher-paying job, he could make a consolidated effort to pay off one of his loans. For instance, if he paid off his personal loan that costs $400 per month, his monthly recurring debt payments would fall to $1,200. As a result, his DTI ratio would decrease to 30% ($1,200 ÷ $4,000 = 0.30).
Further, if James was able to take both of these steps, increasing his gross monthly income to $5,500 and decreasing his monthly debt payments to $1,200, he could effectively decrease his DTI ratio to 22% ($1,200 ÷ $5,500 = 0.22). If this were possible, his DTI ratio would essentially be halved!
While it’s understandable that these measures aren’t always easy, taking incremental steps toward decreasing your DTI can be extremely beneficial in the long run. When in doubt, look over your options and do whatever you can to work toward your financial goals.
Understanding Your Financial Goals
Your DTI ratio is a valuable financial measurement that can help shine some light on your current financial situation. After all, we can’t expect to make tangible financial goals if we don’t have a grasp on where we currently stand.
Think about where you see yourself in a year, or even five years. Do you want to own a house? Or trade in your used car for a new one? If you have a specific financial goal in mind, it’s important to make plans that will help you achieve that goal.
For instance, if you’re currently renting an apartment but you’re interested in buying a house, you can use your DTI ratio to plan for the future.
First, calculate your current DTI. Afterward, the percentage you receive will not only allow you to understand your current financial situation but also make it easier to assess whether or not you need a different job, need to pay off some debts, or even how long it might take to save the money you need for a proper down payment.
In other situations, knowing your financial goals can also allow you to make intelligent investments, as well as avoid falling victim to the most negative side effects of interest or inflation.
Ultimately, no matter what your current circumstances may be, it’s never too late to start looking into aspects of your financial situation, such as your DTI ratio, in order to plan for the future.
- Glossary
- What Is Gross Monthly Income?
- What Is Management?
- What Is A Problem Statement?
- What Is Annual Net Income?
- What Is A Letter Of Transmittal?
- What Is Attrition?
- What Does White Collar Mean?
- What Does Blue Collar Mean?
- What Is Efficiency Vs Effectiveness?
- What Is A Dislocated Worker?
- What Is Human Resource (HR)?
- Thank You Letter Scholarships
- What Is Constructive Criticism?
- What Is A Quarter Life Crisis?
- What Is Imposter Syndrome?
- What Is Notes Payable?
- Types Of Communication
- Economic Demand
- Cost Benefit Analysis
- Collective Bargaining
- Key Performance Indicators
- What Is Gender Bias In A Job Description?
- What Is The Hidden Job Market?
- What Is The Difference Between A Job Vs. A Career?
- What Is A Prorated Salary?
- W9 Vs. 1099
- Double Declining Balance Method
- Divergent Vs Convergent Thinking
- Budgeting Process
- Types Of Intelligence
- What Is Bargaining Power?
- What Is Operating Capital?
- Difference Between Margin Vs Markup
- Participative Leadership
- Autocratic Leadership
- Authoratarian Leadership
- Situational Leadership
- Difference Between Generalist Vs Specialist
- Strategic Leadership
- Competitive Strategies
- Equity Vs Equality
- What Is Marginalization?
- Colleague Vs Coworker
- What Is The Glass Ceiling?
- What Are Guilty Pleasures?
- Emotion Wheel
- Nepotism In The Workplace
- Sustainable Competitive Advantage
- Organizational Development
- Communication Styles
- Contingent Workers
- Passive Vs Non Passive Income
- Choose A Career
- Formulas
- APR Formula
- Total Variable Cost Formula
- How to Calculate Probability
- How To Find A Percentile
- How To Calculate Weighted Average
- What Is The Sample Mean?
- Hot To Calculate Growth Rate
- Hot To Calculate Inflation Rate
- How To Calculate Marginal Utility
- How To Average Percentages
- Calculate Debt To Asset Ratio
- How To Calculate Percent Yield
- Fixed Cost Formula
- How To Calculate Interest
- How To Calculate Earnings Per Share
- How To Calculate Retained Earnings
- How To Calculate Adjusted Gross Income
- How To Calculate Consumer Price Index
- How To Calculate Cost Of Goods Sold
- How To Calculate Correlation
- How To Calculate Confidence Interval
- How To Calculate Consumer Surplus
- How To Calculate Debt To Income Ratio
- How To Calculate Depreciation
- How To Calculate Elasticity Of Demand
- How To Calculate Equity
- How To Calculate Full Time Equivalent
- How To Calculate Gross Profit Percentage
- How To Calculate Margin Of Error
- How To Calculate Opportunity Cost
- How To Calculate Operating Cash Flow
- How To Calculate Operating Income
- How To Calculate Odds
- How To Calculate Percent Change
- How To Calculate Z Score
- Cost Of Capital Formula
- How To Calculate Time And A Half
- Types Of Variables