Debt-to-Income Ratio - Improve Your Financial Health
Your debt-to-income ratio (DTI) is an essential tool for measuring a critical part if your financial health. By calculating your DTI, you can learn about:
- Are you taking on too much debt?
- Can you afford your monthly payments?
- Are you using your income wisely, spending sensibly, and budgeting to build important savings accounts or to cover emergencies?
- Do you use debt to pay for things that you can’t afford?
- Mortgage and personal loan lenders rely on DTI to measure whether you can afford to repay a loan. Too high a DTI and "No loan for you!"
If you track your DTI, you can gain the same insights that lenders seek about borrowing money. Calculate your DTI and judge whether your financial obligations are reasonable for your income or if you are in the danger zone.
Why is Your Debt-to-Income Ratio Important to Your Financial Health?
Your debt-to-income ratio (DTI) shows you how much of your income you use to pay for certain debts. If too much of your income is going to pay off your debt, then you are going to find it hard to pay your other bills, especially emergency bills, or build up any savings.
Your DTI is especially important when applying for a loan. Along with credit scores, lenders use your DTI to determine if you can qualify for a loan. Most mortgage loan programs have very strict debt-to-income ratio rules.
DTI is a formula that compares your required payments on certain debts to your gross income. The debt-to-income ratio can be viewed as a 'front-end' or 'back-end' ratio. The front end ratio divides your gross income by the total of your mortgage payment, property taxes, and homeowner's insurance. The 'back-end' ratio additionally accounts for debts like car payments, credit card debts, and court-ordered child support or alimony obligations. DTI is expressed as a percentage, the percentage of your gross income that the debt payments utilize.
Debt-to-Income Ratio: What is included?
When calculating your DTI it is important to include all of your relevant debt. This includes both household expenses and non-housing expenses.
Your debt-to-income ratio doesn't include everyday expenses or bills, such as gas, non-auto loan transportation costs, utilities, groceries, household repairs or maintenance.
Check out the image to see a list of the various components included in calculating your DTI. If you don't own a home, then use your rent payments to calculate your DTI.
Step 1 - Calculate Your Pre-tax Income:
Use your annual gross income. This is especially important if you have seasonal income, bonuses, or variable income. You can include any of the following: wages, salaries, tips and bonuses, investment income, pension, Social Security, child support and alimony, or any other additional, verifiable income.
Step 2 - Calculate Your Monthly Debt Payments:
Use the monthly payments you are required to make to calculate your debt payments. You can find this information on your monthly statements. You can find all your monthly payment information on your credit report.
Always use the required monthly payment, even if you pay more than your creditor or lender requires. This is especially important for calculating credit card payments, the payment that most commonly exceeds the required minimum.
Your DTI uses your debt payments for any of the following expenses you have.
Monthly housing payments: rent or mortgage. For mortgage include monthly property tax, house insurance, and mortgage insurance payments
Credit card payments based on required minimum payments
Vehicle loans *
Student loans *
Personal loans *
Court-ordered payments such as alimony or child support,
Time share payments
Note: While it is essential to pay all of your bills on time, not all of them are debt. Don’t include groceries, medical or car insurance, entertainment, gasoline, or taxes, unless they are required by a court-ordered judgment. Don't count your cellphone, utilities, or cable bills, even though you pay them monthly.
*Include payments for any loans you co-signed.
Step 3 - Get Your Results
Divide your total debt payments by your gross monthly (pre-tax) income. The result is expressed in percentage. The higher the DTI, the more of your income that you use to service your debt payments. A lower DTI means that you pose less risk to lenders.
Calculate Your DTI Now
Use Bills.com DTI Calculator to learn both your total DTI and your front-end DTI. Get insights on how to improve your DTI and financial health.
Excellent DTI Level - 20% or Less
Ideally, you are not spending too much of your income on housing costs. If you are in a sound financial position, then you may be able to keep your DTI at about the 20% level. If you are a saver, have a sound investment portfolio, and don't carry credit card debt, student debt, or auto loans, then you have an excellent chance to keep your DTI very low.
How can you increase your financial health? Fine-tune your investment, insurance, and long-term planning.
Good DTI: 21% - 36%
If your DTI is anywhere between 20% - 36%, then you are doing a good job and your debt level is healthy in the eyes of mortgage lenders.
Fair DTI: Between 37% - 45%
Mortgage programs have strict DTI requirements. For example, conventional loan programs, such as Fannie Mae, allow a maximum DTI of 45%.
If you are carrying that much debt, then you are going to have a hard time paying an emergency bill, or face a sudden economic hardship, unless you have sufficient savings. Many millennials feel pressure and have higher DTIs due to student loans.
You can improve your DTI by working on your budget. Look for ways to cut expenses, and increase your income. Avoid minimum payments on your credit cards, and pay off your higher interest rate debt more aggressively.
High DTI: Over 45%
If you DTI is over 45%, then you have a combination of too much housing costs and too much debt. A high DTI prevents you from saving.
Your first step is to a good look at your budget. Can you cut expenses? The first place to look for most households is their housing budget. Are you using too much of your income for rent or a mortgage? Consider a cash-out refinance to extend your loan and lower your monthly payments. You could use some of the extra cash to pay off credit card and other debt.
Your DTI Varies - Remember to Track Your Debt-to-Income Ratio
Your DTI is going to vary over time. It is a good idea to see your DTI today and then track it. As you pay down your debt, your DTI is going to drop. Also, if you decide to take a long-term loan, such as a cash-out refinance loan, then your DTI is also going to drop. This is due to the lower monthly payments. Remember, your DTI measures your payments, not your overall debt load. Read below to see three different DTI levels, and ways you can improve your ratio.