Debt-to-Income Ratio (DTI): Why It’s Important and How to Calculate It

Your credit report and credit score aren’t the only variables that can impact your ability to borrow money. You should also be familiar with your debt-to-income (DTI) ratio. It’s a way for lenders to assess your ability to pay back your loans. Here’s how it works and what you can do to improve it.

What is a debt-to-income (DTI) ratio?

Your DTI ratio shows how much of your monthly income goes toward paying down debts. It has two parts: the front-end ratio (housing costs compared to income) and the back-end ratio (all debts compared to income). Lenders consider both ratios in the loan review and approval process.

Why does my debt-to-income ratio matter?

When it comes to borrowing money, lenders use your DTI ratio to figure out if you can handle more debt. Lenders consider your monthly bills when assessing this ratio. A lower DTI ratio, alongside many other factors, can help you get approved. This means you have a healthy balance between debt and income. Conversely, a high DTI ratio might make it harder to get loans. It could also make managing your monthly payments more challenging.

Lenders weren’t always required to consider people’s ability to repay loans. This changed after the 2008 financial crisis to help protect both borrowers and lenders. Keeping an eye on your DTI ratio can help you make smart decisions about taking on new debt. It’s also a useful tool for understanding your overall financial health.

How to calculate your debt-to-income ratio

Calculating your DTI ratio is easier than you might think. To figure out your DTI ratio, divide your monthly debt payments by your monthly gross income, then multiply by 100 to get a percentage.

Here’s how to do it:

1. Add up your monthly debt payments. Include things like your mortgage or rent, credit card minimums, child support, car loans, student loans and other installment loans. Don’t include utilities, groceries or insurance premiums.
2. Calculate your gross monthly income. This is the money you earn each month before taxes and other deductions. If you’re self-employed, use your average monthly income. Be sure to include all income, including side gigs.
3. Divide your total monthly debt by your gross monthly income. This gives you a decimal number. Multiply the result by 100 to get your DTI percentage.

Here’s an example of these steps in action:

• If your monthly debts are $1,200 for a mortgage, $300 for a car loan, $350 for a student loan and $50 for a credit card minimum, your total monthly debt will be $1,900.
• Let’s say your annual salary is $48,000. That means your gross monthly income will be $4,000 ($48,000 divided by 12 months).
• To calculate your DTI ratio, divide $1,900 (monthly debt) by $4,000 (gross monthly income). This gives you 0.475. Multiply that by 100, and your DTI ratio is 47.5%.

What is a good debt-to-income ratio?

Different lenders have different guidelines for what they consider a good DTI ratio. Here’s what various DTI ratio ratios typically mean for your financial health:

• A DTI ratio of 35% or less shows you’re managing your debt well. This range may increase your chances of getting loans with competitive rates. It also means you likely have money left over for saving and unexpected expenses.
• If your DTI ratio falls between 36% and 41%, you may still be in good shape. This range is generally acceptable to most lenders, but you still might want to look for ways to lower your debt.
• A DTI ratio between 43% and 50% means you may want to take a careful look at your debt. Many qualified mortgages have a maximum DTI ratio of 43%, but there are ways to get ahead, such as looking into debt reduction strategies.
• Having a DTI ratio above 50% is a sign you might be carrying too much debt for your income. At this level, it might be more difficult to get approved for new loans or credit cards. Consider speaking with a Navy Federal Credit Union personal financial counselor about ways to lower your debt.

These ranges are guidelines, not hard rules. Some loan programs might accept higher ratios, while others might require lower ones. The key is to keep your DTI ratio as low as possible while managing your financial needs.

How to lower your debt-to-income ratio

There are two helpful ways to work toward lowering your DTI ratio: increasing your income and reducing your recurring debt. Here are some strategies for both.

Common debt-to-income ratio FAQs

A DTI ratio can sometimes raise questions depending on your livelihood or lifestyle. Here are some common questions you might have.

Does your debt-to-income ratio affect your credit score?

Your DTI ratio doesn’t affect your credit score. Credit bureaus don’t include your income information in their calculations. However, both your credit score and DTI ratio are important factors when lenders measure your creditworthiness.

Can I get a loan with a high debt-to-income ratio?

While it’s possible to get a loan with a high DTI ratio, you might have fewer options and face higher interest rates. Some loan programs, like FHA loans, may accept higher DTI ratios. But you’ll likely need to show other strong factors like a good credit score or significant savings.

How quickly can I improve my debt-to-income ratio?

You can see improvements in your DTI ratio as soon as you increase your income or reduce your debt. However, making meaningful changes may take a few months of consistent effort. Focus on steady progress rather than quick fixes.

What debts are included in my debt-to-income ratio?

Your DTI ratio includes mortgage or rent payments, car loans, student loans, credit card minimums, personal loans and other regular debt payments. It doesn’t include utilities, groceries, insurance premiums or other monthly expenses that aren’t debt.

Should I close credit cards to improve my debt-to-income ratio?

Closing credit cards won’t improve your DTI ratio unless you’re paying an annual fee. Your DTI ratio only includes the minimum payments on your credit card balances, not your credit limits. In fact, closing cards might hurt your credit utilization, which could lower your credit score.

What if my income varies each month?

If your income changes from month to month, you can use your average monthly income from the past year to calculate your DTI ratio. This gives lenders a more accurate picture of your ability to manage debt payments.

Will paying off a loan immediately improve my debt-to-income ratio?

Paying off a loan may improve your DTI ratio because you’ll have one less monthly payment to include in your debt total. However, make sure you have enough savings left for emergencies.

High debt-to-income ratio? Get personalized help from Navy Federal

Looking to improve your DTI ratio? Personal Finance Counseling from Navy Federal can help you work toward paying down debt and create a budget that works for your financial situation. Whether you’re getting ready to apply for a loan or working to better manage your finances, we’re here to help.