What is a Debt-to-Income (DTI) Ratio?

A debt-to-income ratio is a percentage that tells you what portion of your income is already dedicated to paying off debt every month. It’s calculated by comparing your monthly debt payments to your gross monthly income. Gross income is your income before taxes and deductions. Your DTI is the primary tool lenders use to assess risk and see your capacity to take on and manage new debt. If your DTI is acceptable (more on that later), you’ll move through to other checks in the process. If it’s not, you could be denied on the spot. A lower DTI can lead to higher chances of loan approval, better interest rates, and potentially larger loan amounts.

Calculating Your Debt-to-Income Ratio

Unlike financial benchmarks that require complicated computations, calculating your debt-to-income ratio is straightforward: take your total monthly debt payments, divided by your gross monthly income, and multiply that number by 100.

DTI = (Total Monthly Debt Payments / Gross Monthly Income) x 100

The hardest part is likely determining your gross monthly income. If you only have one source of income, add up what you’re paid every month before taxes or deductions. If you have other sources of income—as long as they are verifiable and consistent—add in those, too. What qualifies as verifiable and consistent income? Generally, anything that’s documented with pay stubs, tax returns, and W-2s, including:

• Commissions
• Overtime pay
• Alimony
• Child support
• Income from a second job
• Retirement or pension income
• Social Security income

Once you determine your gross income, you’ll need to calculate your total monthly debt payments. Include any recurring debts, such as:

• Mortgage or rent payments
• Minimum credit card payments
• Car loans
• Student loans
• Personal loans
• Child support payments
• Alimony payments

Once you have your gross monthly income and your total monthly debt payments, you’re ready to crunch the numbers. For example: say you have $5,000 in gross monthly income and $2,000 in debt payments. Your DTI calculation is 2,000/5,000 = 0.4, and then multiply 0.4 by 100 to get your DTI of 40%.

Understanding DTI Benchmarks

Once you know your DTI ratio, you need to understand how that number measures up to lender expectations. Here are the generally accepted DTI benchmarks:

• Ideal is 35% or Below: This is considered an excellent DTI and signals healthy debt management. If you fall in this category, you have a high likelihood for loan approval.
• Acceptable is 36%-43%: This is a manageable DTI, and you’re likely to be approved for most loans, but you may have slightly higher rates and more required documentation.
• Needs Improvement is 44% and Above: Borrowers in this category are higher risk, with limited options. You may only qualify for specific loan types or need strong compensating factors like a high FICO® Score and large down payment or savings.

How to Lower Your DTI

There are two ways to lower your DTI ratio: pay down debt to lower your monthly debt payments, or boost your income to increase your monthly gross income. To lower your debt payments, pay down debts with the highest monthly minimums, since this is what lenders use to calculate your DTI. If you have credit cards with high monthly minimums, focus on those first. Avoid carrying new balances or taking on new loans before applying for a mortgage. Consider debt consolidation or loan refinancing to reduce minimum monthly payment amounts. To boost your income, consider finding a second job or side gig. Make sure that all income you bring in is used in the gross income calculation when applying for loans.

Even if you don’t plan to apply for new credit anytime soon, it’s smart to calculate your DTI ratio regularly. If there’s room for improvement, it’s smart to take action now, in advance of when you might need to apply for new credit. Think of your DTI ratio as the breathing room needed in your financial health, not a line to push the limit.