The debt-to-income ratio is the percentage of a consumer’s monthly gross income that goes toward paying debts. Generally, the higher the ratio, the higher the perceived risk. Loans with higher risk are generally priced at a higher interest rate.
In other words, it is the amount of debt compared to your overall income. Lenders use this ratio when determining whether to lend you money. A low debt-to-income ratio is more desirable.
Do you know how much debt you hold? If you’re holding too much debt in relation to your income, it can be a sign of future financial troubles.
Calculate your Debt-to-Income Ratio
If you’ve added all your income before taxes, you can then divide your total debt to your income to calculate your debt-to-income ratio (or DTI). Your DTI ratio is used by lenders to determine your ability to pay existing debt and if your income can handle another monthly payment.
- Step 1: Add your monthly bills (rent or mortgage payments; alimony; child support; student, auto, or other fixed monthly payments; credit card minimum monthly payments; other debts)
- Step 2: Divide the total of your monthly payments by your monthly gross income (income before taxes).
- Step 3: The result is a percentage called your DTI ratio. The lower your DTI the less risky to lenders.
Additionally, knowing your DTI can help you understand the potential risk you’re taking when applying for a new loan. Keeping your debt at a manageable level is one of the foundations of financial wellbeing.
Want to lower your DTI? Increase your income or pay off debts to reduce monthly payments.