How to calculate debt-to-income ratio and what it means

When you apply for a loan or consult a financial expert, you might hear the term debt-to-income ratio, or DTI ratio for short. But what does debt-to-income ratio mean? And why does it matter?

Here’s some helpful information about DTI ratios, including how to calculate your own ratio and steps you can take to improve it.

Key takeaways

• A debt-to-income (DTI) ratio is a snapshot of your income in comparison to your monthly bills and other debts.
• Lenders may use your DTI ratio along with your credit history as an indicator of your financial health.
• Improving your DTI ratio before applying for a loan or credit card could improve your chances of approval. 

A debt-to-income ratio is basically a snapshot of how much of your monthly budget goes toward debt payments. You can find your DTI ratio by dividing the debt you owe by the income you earn. And it’s typically expressed as a percentage.

Lenders often evaluate two different DTI ratios: the front-end ratio and the back-end ratio.

The front-end ratio, sometimes called the housing ratio, shows what percentage of a borrower’s monthly income is used for housing expenses. This ratio could include monthly mortgage payments, homeowners insurance, property taxes and homeowners association dues.

The back-end ratio is the amount of a borrower’s income that goes toward housing expenses plus other monthly debts. And it can include revolving debts such as credit card or car payments, student loans and child support.

Lenders typically say the ideal front-end ratio should be no more than 28%, and the back-end ratio, including all expenses, should be 36% or lower. In reality, depending on your credit score, savings, assets and down payment, lenders may accept higher ratios, depending on the type of loan you’re applying for.

Why does debt-to-income ratio matter? For one thing, your DTI ratio is one way to look at your overall financial health, according to the Consumer Financial Protection Bureau (CFPB). The CFPB also says that having a DTI ratio that’s too high could affect your ability to get approved for new credit. 

Your debt-to-income ratio can help lenders determine whether you can manage additional monthly payments and how likely you are to repay a loan on time. Remember that lenders might look at many other factors, such as your credit scores, too.

Learning how to figure out your debt-to-income ratio takes a little basic math.

Step 1: Add up all your monthly debt payments

That can include things such as your mortgage, student loans, auto loans, credit card payments and personal loans. And if you have court-ordered payments such as alimony or child support, those count too. 

Step 2: Figure out your gross monthly income

This is the amount you earn every month before things such as taxes, insurance and Social Security are taken out. Don’t forget to include any court-ordered payments you receive. If your income varies, the CFPB recommends estimating what a typical month’s income would be.

Step 3: Divide to get your debt-to-income ratio

Now that you’ve gathered your monthly debt payments and gross monthly income, let’s do a little math. Divide your total monthly debt payments by your gross monthly income.

Step 4: Make it a percentage

Multiply your answer by 100 to get your debt-to-income ratio as a percentage.

Don’t worry if it’s still a little confusing at first. Here’s an example so you can see how it works: 

If you pay $200 a month for a car loan and $200 for your student loans, your total monthly debt is $400. 

And if, for example, your gross monthly income is $2,000, that would mean your DTI ratio equation is: 400 divided by 2,000 = 0.2.

Then, multiply 0.2 by 100 to get your DTI ratio as a percentage. In this example, it’s 20%. This means that 20% of your monthly income goes to debt payments. The CFPB also has a debt-to-income ratio calculator if you want some help figuring out your DTI ratio. 

What’s considered a good debt-to-income ratio depends on your unique situation and whether you’re buying a home or attempting to refinance. But the CFPB offers some general guidance. 

For homeowners, the CFPB recommends keeping your DTI ratio for all debts—including your monthly mortgage payment—at 36% or less. The CFPB also notes that 43% is typically the highest DTI ratio you can have for a qualified mortgage. 

For renters, the CFPB recommends trying to keep your DTI ratio for all debts at 15%-20% or lower. And the CFPB says not to include your rent payment when calculating your DTI ratio for this purpose. 

If you’re struggling to keep your DTI ratio at or around these guidelines, the CFPB recommends reaching out to a U.S. Department of Housing and Urban Development counselor for help with housing issues

Your DTI ratio may not directly impact your credit scores. But there are some indirect ways that your DTI or income can impact your credit scores.

For example, your credit utilization ratio may account for nearly 30% of your credit scores. And it looks at outstanding balances on your credit cards relative to your total available credit. Reducing your credit utilization ratio will also reduce your DTI ratio and could improve your credit scores. 

But a loss of income could make it difficult to pay your bills on time. And late or missed payments could affect your credit scores. That’s because a loss of income can change your DTI ratio.

Here are few things to consider if you want to reduce your debt-to-income ratio or learn how to use credit wisely: 

Avoid taking on new debt

Avoiding debt can help build your financial well-being, according to the CFPB. And because your DTI ratio depends on your amount of debt versus your income, taking on more debt without growing your income will increase your DTI ratio. So it’s a good idea to apply only for the credit you need and avoid taking on new debt.

Pay down existing debt

There are a few different strategies for paying off debt. The CFPB talks about the snowball and highest-interest-rate methods. But there are many more strategies for handling loan payments—such as consolidating debt—that you might explore, too. 

Before you make any decisions, consider talking to a qualified financial professional to figure out a debt management plan for your specific situation. You might even have access to some financial planning services through your employer or retirement plan administrator.

Pay more than the minimum

The CFPB recommends paying more than the minimum payment on your credit cards whenever possible. This may help you reduce your credit card debt faster and minimize credit card interest charges. It can also help your credit utilization ratio, which can be an important factor in calculating your credit scores.

Use a budget

The CFPB says that making and sticking to a budget is an important step toward getting your debt under control. They even provide a budget worksheet to help you get started. You might also consider learning more about how to budget with a credit card.

A borrower’s debt-to-income ratio can influence lending decisions. That’s because DTI ratio is one factor lenders might review to determine how likely someone is to repay debts. Keeping your debt-to-income ratio as low as possible may help you secure better terms for your loans or credit cards.

If you want to lower your debt-to-income ratio, you can read these strategies for paying off debt.