Your debt-to-income (DTI) ratio is a financial metric that lenders use to assess your ability to manage your debt and make timely payments. It is calculated by comparing your monthly debt payments to your monthly gross income. The formula for calculating DTI is as follows:
DTI Ratio = (Total Monthly Debt Payments / Gross Monthly Income) x 100
Here’s a breakdown of the key components of this formula:
1. Total Monthly Debt Payments: This includes all of your monthly debt obligations. Some common examples of debts included in this calculation are:
- Mortgage or rent payments
- Monthly credit card payments (minimum payments)
- Car loan payments
- Student loan payments
- Personal loan payments
- Alimony or child support payments
- Do not include expenses like utilities, groceries, or insurance premiums in this calculation, as these are not considered debt payments.
2. Gross Monthly Income: This is your total monthly income before taxes and other deductions. It includes your salary or wages from your job, any rental income, alimony, child support, and any other sources of income you may have.
Once you have calculated your DTI ratio using the formula, you’ll get a percentage. For example, if your total monthly debt payments amount to $1,500, and your gross monthly income is $5,000, your DTI ratio would be:
DTI Ratio = ($1,500 / $5,000) x 100 = 30%
In this example, your DTI ratio is 30%, which means that 30% of your gross monthly income goes toward paying off debts.
Lenders use your DTI ratio to evaluate your creditworthiness when you apply for credit, such as a mortgage or a loan. A lower DTI ratio generally indicates that you have a lower level of debt relative to your income and may be seen as less risky by lenders. Lenders typically have maximum DTI ratio requirements for different types of loans, so it’s important to be aware of these requirements when applying for credit.