Debt-to-income ratio (DTI) is the amount of debt you have in relation to your gross monthly income, which is your monthly income before taxes and other deductions. Your debt is considered to be all of your monthly payments on loans, credit cards and other regular monthly debts. This doesn’t include everyday items, like food and gas.
The DTI ratio is used by lenders to calculate your ability to repay the loan. The lender wants to make sure that you’re not going to be scrambling to find money every month to make your loan payments. If your debt-to-income is too high, that scrambling is more likely that if it’s not too high.
DTI is used by lenders for consumer loans. It’s also used by mortgage underwriters and loan officers. It’s not used by not credit card issuers when issuing credit cards however.
The exact formula to calculate the debt-to-income ratio is the applicant’s monthly debt obligations divided by his or her gross monthly income. For example, if you pay $2,000 towards your debt every month and your gross monthly income is $8,000, you divide 2,000 by 8,000. The final number comes out to 0.25, or a 25% debt-to-income ratio. 25% DTI is a good percentage to have.
You can calculate your DTI using an online debt-to-income ratio calculator.
Debts that go into the calculation include credit card payments (the minimum required), your mortgage loan, auto loan, student loan payments, child support and/or alimony and any other recurring monthly debts, for example a personal loan.
Your gross income is the income you get before taxes and other deductions come out. It’s what you make and not what you actually take home.
A Good Debt-to-Income Ratio Goal
You want a reasonably low DTI ratio, especially if you’re in the market for a new loan. If you track your debt-to-income ratio, make sure it stays in a low range. A low DTI gives you more spending money every month. It ensures that you’ll be a little more comfortable financially day-to-day. And, it ensures you’re more likely to qualify for a loan when you need one.
Debt-to-Income Ratio and a Mortgage Loan
Debt-to-income ratio is often used for determining mortgage rates and the monthly mortgage payment.
For a mortgage loan, mortgage lenders generally follow a guideline of 28/36 when it comes to debt-to-incomes ratios. Those numbers—28 and 36—are the “magic” numbers. These are the ideal maximum numbers many lenders want when extending you a mortgage loan.
- 28 indicates that your housing expenses won’t be more than 28%. Housing expenses include homeowner’s insurance, property taxes, PMI (private mortgage insurance), flood insurance and homeowner’s association fees, etc.
- 36 is your DTI and means that your total debt-to-income ratio that isn’t more than 36% of your gross monthly income.
The additional expenses included in this 28/26 formula depend on which financial institution you’re looking at. At or below a 36% DTI is considered the ideal ratio to have. 45% is considered a maximum. Although, a much lower DTI is preferred—18%, for example, is considered excellent. And some lenders will accepter a higher ratio.
To muddy the waters, your DTI is really only one criteria lenders look at. So, in and of itself, your DTI isn’t guaranteed to make your break your loan approval.
Medical Debts and Your DTI
Medical bills aren’t used in calculating your debt-to-income ratio, unless you don’t pay them and they end up in collection.
Some companies, like Experian, no longer display medical collections on your credit report until they’re at least 180 days past due. Once on your credit report, medical collections can remain for seven years from the original delinquency date and can hurt your credit scores—and your chances of getting a loan—just like any other collection account.
How DTI Impacts Your Credit
Your DTI is only loosely related to your credit and your credit score. It doesn’t affect your credit. Your income isn’t calculated in your credit score, so DTI is a separate measure. Debt usage is loosely related to credit and your credit score. But the only connection between debt usage and your debt-to-income ratio is your monthly debt payments. For DTI those payments are a criteria in and of themselves. For your credit and credit score, those payments are relevant only in their relation to your overall available revolving credit limit, primarily credit card debt versus credit card limits.
A mortgage lender will look at your DTI and your credit score separately. The secret for you is to keep your debt usage—or credit utilization ratio—to 30% or less with 10% being ideal. Your debt usage measures the total amount of revolving credit you have available—your credit line(s)—compared to the amount of those credit lines you’re actually using.
The monthly minimum payments on your credit lines factors into your DTI, but not your available credit limit.
Payment to Income Ratio (PTI)
A similar ratio to your debt-to-income ratio is your payment-to-income ratio or PTI. PTI is used for auto loans. It helps lenders estimate what you can afford on a car loan.
While your current car payment is part of your DTI, auto loan lenders take your PTI into consider when considering you for a car loan. Lenders typically consider a payment to income ratio of 15 to 20% to be the maximum threshold.
To find your PTI, take your estimated car and insurance payment and divide it by your pre-taxed or gross monthly income.
- Multiply your gross monthly income by 0.15. So, if your income is $8,000 a month, that amount multiplied by 0.15 equals 1,200. $1,200 is then seen as the maximum your car—whether first, second or third—and insurance payment can be for lenders who use a 15% PTI ratio limit. Note that some use a 20% PTI.
- To calculate for a 20% PTI ratio cap, do the same equation but multiply by 0.2 rather than 0.15.
You can use both your debt-to-income ratio and your payment-to-income ratio to your advantage. The obvious advantage is calculating your debt-to-income ratio if you need a mortgage and your payment-to-income ratio if you’re considering a new car.
A less obvious advantage in checking on your ratios once in a while is to help you keep control of your spending versus your income. It never hurts to see where you are financially on any front.