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How To Calculate DTI
By Ellie Diamond MONEY RESEARCH COLLECTIVE
If you’re worried about debt, you’re not alone. According to the Federal Reserve, Americans lose nearly 10% of their disposable income to personal debt.
Lenders don’t mind debt if your income is high enough. But debt that creeps too close to your earnings affects your debt-to-income ratio (DTI) — the number lenders consider when approving you for a loan.
In this article, you’ll learn how to calculate DTI and why doing so is worth your time.
What is a DTI (debt-to-income) ratio?
A DTI ratio is the percentage of your total monthly income that goes toward debt payments. It’s a quick snapshot of how much you owe versus how much you earn, essential information if you plan to apply for a mortgage or other loan.
Front-end ratio
Your front-end ratio is a DTI that only includes housing expenses. This is the first ratio to consider if you want to buy a house. Lenders use this ratio to determine how large of a mortgage you can afford.
Your front-end ratio usually includes your mortgage principal, interest, taxes and insurance — or PITI. If you’re a renter, it includes your monthly rent.
Back-end ratio
A back-end DTI ratio includes housing expenses plus long-term debt. Long-term debt is any debt that comes due in a year or longer. Lenders don’t consider credit card debt long-term if you pay it off monthly, but any ongoing balances may count.
What’s considered a good debt-to-income ratio?
According to the Federal Deposit Insurance Corporation (FDIC), lenders prefer a back-end DTI ratio of no more than 33% to 36%. Individual lenders’ maximums tend to fall within this range.
For example, the FDIC suggests if you earn $10,000 a month before taxes, your housing expenses plus long-term debt payments should be no more than $3,600. If you earn $5,000, those costs should stay below $1,800.
Front-end DTI maximums are lower because they only include housing costs. The upper range for front-end DTI is 25% to 28%. That’s $2,500 to $2,800 for a $10,000-a-month earner and $1,250 to $1,400 for a $5,000-a-month earner.
These numbers can help you establish your borrowing budget. Financial institutions are less likely to approve your loan application if your DTI exceeds the maximum. The further below the maximum you fall, the better your terms will be. In short, it’s ideal to keep your debt-to-income ratio as low as possible.
How to calculate your DTI ratio in 3 steps
The debt-to-income ratio formula is your gross monthly income divided by your monthly debt payments. It’s a straightforward calculation, but if you don’t already keep a close eye on your finances, you might need to do some preliminary math.
Here’s how to calculate debt to income ratio. An online DTI calculator may also help.
1. Tally up all of your monthly debt payments
DTI considers all monthly expenses that go toward lenders or creditors. Examples of those monthly payments include:
- Student or auto loans
- Mortgage payments
- Personal loans
- Medical debt payments
- Credit card balances
Don’t count variable and daily expenses, such as food or medication.
2. Divide your debt by your total gross monthly income
Gross monthly income is the total amount you earn before taxes and other deductions. If you earn a salary, divide that annual number by 12 to find your gross monthly income.
If your income varies — for example, if you’re a seasonal earner or freelancer — use the gross annual income on your most recent tax return. Make any necessary adjustments if your yearly income has changed significantly.
Then, divide that gross monthly income by the expenses total from Step 1.
3. Multiply this number by 100 to get a percentage
The answer is the share of your income that goes toward paying off your debt, or DTI. The lower that number, the better.
What makes the debt-to-income ratio so important?
Your debt-to-income ratio is a snapshot of how well you manage your money. It’s important because lenders use it to determine if you’d be able to pay them back. If your DTI is high, you’ve taken on more debt than you can afford.
Remember, DTI doesn’t include daily expenses like food and clothing. If your debt payments are too high, your total expenses could exceed your earnings.
It offers a peek into your financial health
Your debt-to-income ratio tells you how much of your income is “spoken for.” For example, if 35% of your monthly earnings go toward debt payments, you only have 65% left to spread around. That 65% needs to include income taxes and all necessary living expenses.
Compare your DTI ratio to the typical maximums of 36% at the back end and 28% at the front end. If you’re approaching — or are above — that number, you live closer to the edge than the experts recommend.
It allows lenders to assess your borrowing risk
Lenders need to know you’ll be able to pay back what you borrow. If you spend 40% or even 50% of your gross monthly income to pay off debts, there’s not much left for daily necessities, let alone another loan.
Many people don’t know their DTI ratio until they apply for a loan. They’re in for a surprise if that ratio is too high for the lender to approve them — or just enough to get a loan but at a high interest rate.
It helps you understand what you can and can’t afford
Other than debt, most expenses are variable, even if it takes effort to adjust them. You can almost always cut your grocery budget or cancel your Netflix subscription. You can’t cancel your loan payments.
Your DTI ratio gives you a baseline, so you know whether you can apply for that car loan or invest in some new tech.
If you’re considering a new home purchase, your front-end DTI ratio estimates what mortgage you can afford. To be safe, try to budget below your approved maximum.
Lowering your DTI ratio
You can lower your DTI ratio from both ends: income and expenses.
Increase your current income
Income counts toward DTI if it’s regular and verifiable. That includes full-time work as well as reliable part-time or side gigs.
If you’re already employed, ask for a raise. If you can’t earn enough at your current job (or don’t have one in the first place), start searching for the right position.
Finally, don’t discount the power of the side hustle. Landing an hourly gig outside your normal work hours is a way to increase your income quickly. You can also look for freelance opportunities, though those won’t count toward your DTI until they generate regular income.
Pay down your debts faster
The two most popular ways to pay off debt are:
- The snowball method: Pay the minimum on all your debts except the smallest ones. Put the rest of your available debt payment funds toward that smallest debt until it’s gone, then focus on the next smallest.
- The avalanche method: Pay the minimum on all monthly bills, then apply the rest to the debt with the highest interest rate. This minimizes interest accrual, so your debt doesn’t grow as quickly.
Another option is to consolidate your debts through a debt consolidation loan or balance transfer credit card. This process collects multiple debts, such as loans or credit card debt, into a single balance. You still owe the same amount, but the interest may be lower, and you only have one payment to make instead of several.
If you’ve fallen significantly behind on bills, you might need to work with debt collectors. In exchange for getting rid of debt, lenders sell the debts to collection agencies for a portion of the original amount. The collector then owns that debt and will pursue you for payment. They will ask for the total amount, but you may be able to negotiate with debt collectors.
Most collections activity will remain on your report for seven years. However, you may be able to remove collections from your credit reports. Some agencies will remove paid debts as an act of goodwill.
Cut your costs wherever possible
Although daily expenses aren’t part of your DTI, cutting back on expenses can free up more money for you to pay off debts.
The classic advice is to cut down on “luxuries.” But here are some more ideas:
- Shop around for insurance: Research your car, home or renters insurance options at least once a year. Get quotes from multiple companies to find the best deal.
- Choose cheaper streaming plans: Switch from ad-free to ad-supported options to get the same shows for less money.
- Change your cell phone plan: Look beyond the “big name” carriers for plans that cost less per month.
- Cancel subscriptions you don’t use: Many people pay for subscription services that they don’t use. Make sure to review them and cancel any you don’t need.
- Make energy-smart utility choices: Replace your traditional light bulbs with LEDs and consider buying a programmable thermostat if you don’t have one yet.
- Create a personal budget: Determine how much you can spend per week. For groceries, create a meal plan that’s appealing and affordable.
Remember, the goal isn’t to deprive yourself but to spend smarter. You might have to cut back on some extras — and the more you do, the more you’ll save — but you don’t have to go bare-bones. Quality of life matters, too.
Where to go from here
Now that you’ve learned how to calculate DTI — and improve it if necessary — decide which steps to take first. It’s unrealistic to expect yourself to get a new job, build a side hustle, shop for new insurance policies and pay down your debt simultaneously. Consider the most impactful first step in your situation, then move forward one step at a time.
Improving your DTI is a long-term project but worth the effort. Plus, as your DTI improves, you’ll most likely improve your credit score.
Your credit score tells lenders how responsible you are at paying bills on time and living within your means. A good credit score will qualify you for lower interest rates and better terms, including lower down payments. A bad credit score — typically anything below 579 on the FICO scale or 600 on VantageScore — can make it harder to borrow.
A great credit score and low DTI will make you an appealing borrower to even the toughest lenders.