What Is Debt-To-Income Ratio
Debt-to-Income (DTI) ratio is a financial metric that compares your total monthly debt payments to your gross monthly Income. It’s expressed as a percentage; the lower this percentage, the more favorable your financial standing.
Debt-To-Income Ratio Calculator
3-Step Guide On How To Use The DTI Ratio Calculator
Calculating your Debt-to-Income (DTI) ratio is a three-step process that gives you a clear picture of your financial standing.
Step 1: Sum Up Your Monthly Debts
First, let’s get all your monthly debts in a row. This includes everything from car loans to your Netflix subscription if it’s a regular debt and, yes, even that new couch you’re financing. Don’t forget loans you’ve co-signed or joint accounts, as they count too.
For loans with a set monthly payment, like your car or personal loan, plugin that fixed amount. Use the minimum payment you must make for debts that can change from month to month, like your credit card.
Got a mortgage? Remember to include principal, interest, taxes, and insurance (PITI). If you set aside money each month for taxes and insurance, include that total in your monthly mortgage payment.
Here’s an example:
- Mortgage (including PITI): $1,200
- Car Loan: $250
- Credit Cards: $150
- Student Loans: $100
- Furniture Financing: $50
- Netflix Subscription: $15 (example addition)
Total Monthly Debts: $1,765 (adjusted total)
Step 2 : Add Up Your Monthly Gross Income
Next up, let’s look at your Income before anything gets taken out (that’s your gross Income). This includes your main Job, any side gigs, and yes, even that weekend freelancing you do. If you’re self-employed or have irregular Income, you’ll need to average it over the year.
If you have rental properties, include the Income from those, too. Just remember, lenders might only let you count part of that rent money, usually around 75%, to cover potential vacancies or repairs.
Here’s what it might look like:
- Main Job: $4,500
- Side Job: $500
- Weekend Freelancing: $300
- Rental Income (75%): $750
Total Monthly Gross Income: $6,050
Step 3: Find Your DTI Ratio
To get your DTI ratio, divide your total monthly debts by your total monthly gross Income:
Total Monthly Gross Income: $6,050
Total Monthly Debts: $1,765
Now, to find the DTI ratio, we’ll divide your total monthly debts by your total monthly gross Income:
$1,765 / $6,050 ≈ 0.2917
To convert this into a percentage, we’ll multiply by 100:
0.2917×100=29.17%
So, with these numbers, your DTI ratio would be 29.17%. This is an excellent ratio as it’s significantly below the ideal threshold of 36%. It indicates to lenders that you’re managing your debts efficiently and have a good portion of your Income left over after covering monthly debt payments.
A lower DTI ratio like this can make you a more attractive candidate for loans and credit.
Why is it Important?
Knowing your DTI is super important because it’s like a financial report card that banks look at when you ask for a loan. If your DTI is low, it tells the bank, “Hey, I’ve got my money under control,” they’re more likely to lend you money. But if it’s high, the bank might think you’re stretching your budget too thin.
How Do Banks Use It?
Banks use your DTI to determine whether lending you money is a safe bet. They prefer lending to people with a lower DTI because it means they’re good at handling their bills and are less likely to miss payments.
What Is An Ideal Debt-To-Income Ratio?
The debt-to-income (DTI) ratio plays a crucial role in managing your finances. Lenders look favorably upon an ideal DTI ratio, which typically falls below 36%. This magic number indicates that you’re not overburdened by debt and are more likely to manage additional loans effectively.
A lower DTI ratio is always better, as it suggests that a more significant portion of your Income is free from debt obligations, giving you financial breathing room. For mortgages, specifically, lenders might prefer a DTI even lower than 36%, with some going as low as 28%-35% for the portion of the debt servicing the mortgage.
Example To Understand The Importance Of The DTI Ratio
Let’s say your friend Alex has a job paying $3,000 monthly before taxes. Alex has a few monthly debts: a car loan that costs $300, a student loan payment of $150, and a credit card bill of $100.
To figure out Alex’s DTI, we’d add up all the debts:
300 (car loan) + 150 (student loan) + 100 (credit card) = $550 (total monthly debt)300(car loan)+150(student loan)+100(credit card)=$550(total monthly debt)
Now, we take that total monthly debt and divide it by Alex’s monthly Income:
$550 / $3,000 ≈ 0.1833
To turn it into a percentage, we multiply it by 100:
0.1833 * 100 = 18.33%0.1833×100=18.33%
So, Alex’s DTI ratio is 18.33%. This is a pretty good DTI because it’s well below 36%, which lenders often consider a healthy limit. This means Alex uses less than a fifth of his Income to pay his debts, and he has the rest to pay for other expenses and savings. It’s a simple way to keep an eye on financial health and make sure debts don’t take over the paycheck.
Conclusion
In conclusion, understanding your Debt-to-Income (DTI) ratio is a fundamental aspect of managing your personal finances. It provides a clear picture of your financial commitments relative to your income, serving as a key indicator of your financial health. A lower DTI ratio is often associated with a better likelihood of loan approval and favorable borrowing terms.
We encourage you to also explore our APR Calculator to gain insights into the annual percentage rate of loans, which can further enhance your financial decision-making. Together, these tools offer a comprehensive understanding of your financial landscape, paving the way for a more secure and prosperous financial journey.