Do you ever feel like your entire paycheck goes straight to loans and other debts? There’s a logical reason for this — your debt-to-income ratio (also known as DTI) is too high.
If your DTI percentage is high, it can make your debt load seem unmanageable. It also impacts other personal finance goals such as going back to school, building credit, or buying your first home.
Find out how to calculate debt-to-income ratio — and how to improve it to get the best deals on loans.
What is debt-to-income ratio?
Your debt-to-income ratio is a simple calculation of how much of your income goes towards debt payments and other financial obligations, such as rent. The lower your debt-to-income ratio, the better your overall financial situation will be.
The exact formula for how to calculate debt-to-income ratio is comprised of dividing the total of all your monthly debt payments by your gross monthly income:
- DTI = total monthly debt payments / gross monthly income
How does DTI affect your finances?
Financial institutions view your debt-to-income ratio as a gauge of your overall financial fitness.
DTI is a measure of your risk as a borrower. The higher your DTI is, the more likely you are to default on a mortgage loan or other debt payment — at least, that’s how the bank sees it. This figure is simply a way for lenders to measure your ability to repay money you’ve borrowed.
Because of this, knowing how to calculate debt-to-income ratio and keeping track of it is extremely important. It could be the deciding factor when you’re trying to get approved for a mortgage or car loan.
One thing to note: A debt-to-income ratio does not have an affect on your credit score directly. While credit bureaus do keep track of your gross income, they don’t use it as part of their calculations.
However, the amount of credit card debt you have in comparison to your credit spending limits (also known as your credit utilization ratio) does have an impact on your credit score. While this is a different topic, it’s important to keep that in mind.
How to calculate debt-to-income ratio
Before further explaining what a good DTI should be, let’s talk about how to calculate your debt-to-income ratio.
Implementing the formula from above, start by adding up your monthly debt obligations. Don’t forget to include your mortgage, home equity loan payments, car loans, student loans, and credit card debt, in addition to any other loans you might have.
Next, add up your total monthly gross income. This includes income from your day job, freelancing, side hustle, weekend gigs, passive income, and any investments.
Once you have both of these figures, your personal debt-to-income ratio is determined by taking your total debt and dividing that by your gross monthly income.
For example, my husband and I have a debt-to-income ratio of 25 percent, which is made up of a pretty large rent payment and a business loan. Neither one of us has student loan debt or car loans, since we paid those off a few years ago. Here’s our personal DTI formula:
Total debt obligations: $2,070
Total gross monthly income: $8,000
Debt-to-income ratio = 2,070 / 8,000 = 25.87 percent
To make it easy, simply add all your information into this calculator:
What is a good debt-to-income ratio?
So what is a good debt-to-income ratio, exactly? It depends on the type of loan you’re applying for.
If you’re in the market for a house, for example, most lenders require a 43 percent or less debt-to-income ratio for mortgage loans to be approved. This number is pretty high, and if you were actually putting over 40 percent of your money towards housing every month, it would likely be very difficult to maintain.
A low debt-to-income ratio is better. This looks more appealing to financial institutions and helps bolster your credit rating. Plus it gives you more cash flow every month. A DTI that’s smaller than 36 percent is advisable, with no more than 28 percent of that going towards housing payments.
In general, paying around 25 percent of your gross income towards debt is much more manageable. So many experts will advise you to aim for 20 to 25 percent DTI when possible. This leaves more money in your pocket for other bills and financial goals. (Hello, retirement fund!)
The bottom line about debt-to-income ratio
Do whatever you can to lower your debt-to-income number as much as possible, and your finances will thank you.
This includes paying down your credit card balances, reducing your housing expenses, and refinancing your student loans when possible. In addition to reducing your debt load, work towards increasing your gross income, as both of these factors will help your DTI.
The lower your ratio, the better you’ll be able to weather any financial emergencies that come your way. It’s a smart move to calculate your personal debt-to-income ratio and take action on reducing that number.
Interested in refinancing student loans?Here are the top 6 lenders of 2018!
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1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 6.97% APR (with Auto Pay). Variable rate loan rates range from 2.47% APR (with Auto Pay) to 6.23% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of Month/Day/Year, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 08/21/18. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at firstname.lastname@example.org, or call 888-601-2801 for more information on ourstudent loan refinance product.
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2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
Savings example: average savings calculated based on single loans refinanced from 9/2013 to 12/2017 where borrowers’ previous rates were disclosed. Assumes same loan terms for previous and refinanced loans, and payments made to maturity with no prepayments. Actual savings for individual loans vary based on loan balance, interest rates, and other factors.
Application detail: 5 minutes indicates typical time it takes to complete application with applicant information readily available. It does not include time taken to provide underwriting decision or funding of the loan.
Instant rates mean a delivery of personalized rates for those individuals who provide sufficient information to return a rate. For instant rates a soft credit pull will be conducted, which will not affect your credit score. To proceed with an application, a hard credit pull will be required, which may affect your credit score.
Total savings calculated by aggregating individual average savings across total borrower population from 9/2013 to 12/2017. Individual average savings calculation based on single loans refinanced from 9/2013 to 12/2017 where borrowers’ previous rates were provided. Assumes same loan terms for previous and refinanced loans, and payments made to maturity with no prepayments. Actual savings for individual loans vary based on loan balance, interest rates, and other factors.
3 Important Disclosures for SoFi.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.47% – 6.99%3||Undergrad & Graduate||Visit SoFi|
|2.47% – 6.23%1||Undergrad & Graduate||Visit Earnest|
|2.47% – 8.03%4||Undergrad & Graduate||Visit Lendkey|
|2.95% – 6.37%2||Undergrad & Graduate||Visit Laurel Road|
|2.48% – 6.25%5||Undergrad & Graduate||Visit CommonBond|
|2.72% – 8.32%6||Undergrad & Graduate||Visit Citizens|