Although you probably have a good idea of how your credit score can affect your ability to get the best deals on loans or other credit, you may not be aware of another important number that helps determine your financial future. Debt-to-income ratio, or DTI, is all of your monthly debt payments divided by your gross monthly income and expressed as a percentage. This is one of the main things your lenders will look at when determining if you’ll be able to meet your monthly payments.
The DTI doesn’t measure your total debt load against your total annual income, but your monthly debt payments against your monthly income. Your DTI is more likely to be a concern for the high-ticket items, such as buying a house, but can still affect your ability to rent an apartment or leasing a car. Some of the debts that go into determining your DTI are mortgage, rent, car loans, monthly credit card payments, alimony, child support, and student loans. The monthly bills that don’t enter the equation are things like phone provider, cable, and internet, since these are debts that can be cancelled. Other recurring bills, such as water and electricity, are also not part of the mix.
But there’s some good news: DTI doesn’t just take into account your work income, but other factors as well, such as alimony, child support, pension, and Social Security. In other words, if it’s on the books, it’s acceptable as part of your DTI. It’s fairly easy to figure your DTI on your own: add all of your monthly debt payments and divide them by your monthly income. Again, you can disallow things like utilities when calculating your DTI.
Let’s say you have $1000 in debt each month, and your income is $3200. Just divide 1000 by 3200 and you get .3125. For convenience’s sake, round that to .31, multiply by 100, and you get a 31% DTI. Or, in other words, 31% of your monthly income goes toward debt.* This is one of the big factors lenders look at when deciding if you’ll be able to repay a new debt on top of what you already owe. Obviously, it’s in your best interests to keep your DTI fairly low, but what’s the highest you can go and still realistically expect to get approved for a loan?
Fannie Mae guidelines say 50% is an acceptable DTI ratio when applying for a mortgage, but according to the Consumer Financial Protection Bureau, 43% would be a better number, and anything below that would certainly be to your advantage. Some landlords and auto loans may be more lenient if your overall credit score is good, but it’s a good idea to try to keep your DTI somewhere below 30%.
If you want to take out a loan but your DTI ratio is up there, you may want to wait until you’ve managed to lower it, and the only way to do that is to pay down — or pay off — other outstanding debts. This is going to take some serious cuts on your part, such as doing away with that morning cup of Starbucks on your way to work or taking your lunch with you in a brown bag instead of eating out. Pay off your credit card with the highest balance, then use the money you would have put toward that monthly bill to pay more than the minimum on your other cards. And while you’re paying down your debt, don’t take on any more debt. Avoid using your credit cards or you’ve gained nothing.
* Huntsberger, Alex. “What is your Debt-to-Income Ratio?” OppLoans, May 3, 2019