DTI: Explaining debt-to-income ratio and why it matters

Debt-to-income (DTI) ratio is a common calculation used by mortgage lenders to compare your amount of debt to your gross monthly income (the amount of money you earn monthly). But why is DTI important to your mortgage lender?

During the mortgage process, lenders use DTI to evaluate your ability to manage your finances and pay back debt. Your DTI is often evaluated alongside other factors, such as your credit score and employment history, to tell a cohesive story about your finances. These factors help lenders determine how much money you may qualify for in a loan.

To calculate your personal DTI ratio, first you need to know your total monthly debt payments. Be sure to include the following monthly payments if they apply to you:

• Credit card monthly payments (use the minimum payment required)
• Student loan payments
• Car loan payments
• Child support or alimony payments
• Existing mortgage payments
• Any additional loan payments

Monthly expenses, such as groceries, gas, utilities, and taxes are not generally included in this initial sum.

Once you’ve totaled your monthly debt payments, divide that number by your gross monthly income (this is your income before taxes are taken out, and can include your salary, bonuses, income from freelance work, or money received from Social Security or child support payments).

Once you’ve divided your total monthly debt by your monthly income, multiply that number by 100 to get a percentage. This is your DTI ratio. To put this into practice, let’s take the following monthly expense breakdown as an example scenario: 

• Gross monthly income: $5,000
• Monthly student loan payment: $300
• Monthly auto loan payment: $350
• Monthly credit card payments: $600

To find your DTI in this scenario, first add your debt payments together (your student loan, auto loan, and credit cards) to get a total of $1,250. Then, divide $1,250 by $5,000 (your gross monthly income) to get 0.25. Multiply by 100 and you have your DTI: 25%.

Unlike a credit score, where a higher number is typically more ideal, a lower DTI is favorable. Every consumer’s DTI ratio will tell a different story, but you can interpret your DTI ratio with the following ranges as a guideline:

• Looking good (35% or less) – This ratio generally indicates your debt is at a manageable level and that you’ll likely have money left over for saving or spending after tending to your bills and debt.
• Opportunity to improve (36-49%) – This ratio typically indicates you’re adequately managing your debt, but you may have opportunities to lower your DTI and put yourself in a better position to handle unexpected expenses.
• Take action (50% or more) – This ratio generally indicates to lenders that you may have more limited borrowing options. You may want to explore methods to improve or lower your DTI to better prepare for managing your debts and saving more money.

While there isn’t a universal DTI threshold for whether a lender will approve you for a mortgage, there are several strategies you can put into place if you want to lower your DTI ratio:

• Pay off debt early – This is typically the fastest way to lower your DTI. Paying more than your minimum required payment can help you pay off debt faster, which could shrink the monthly debt portion of your DTI ratio.
• Budget and adjust your spending habits – If you’re looking to pay off debt more quickly, you may have to reallocate some of your budget for other goods, especially when it comes to non-essential purchases or expenses.
• Find ways to increase your income – Side jobs or raises to your existing salary can be considered extra income, which may be able to offset a higher debt balance in your DTI ratio.

Talk with a home mortgage consultant about your DTI ratio and what your options may be.