Debt-to-Income Ratio (DTI): The What and Why

by Julia Guardione Updated on: July 2, 2019

If you’ve ever applied for an auto, home, or personal loan, you may have heard your financial institution mention your debt-to-income ratio. Your debt-to-income (DTI) ratio is the amount of all your monthly debt divided by your gross monthly income. This ratio is used by lenders to determine your ability to manage all of your monthly payments to repay the money you borrow.

Why? Studies of mortgage loans have shown that borrowers with a higher DTI are more likely to have trouble making payments. Because their budget is more tied-up, when other unexpected costs arise, those with a tighter budget (i.e. more debt expenses) will have less wiggle room to afford both debts and life’s unexpected challenges.

Calculating your DTI is simple. Just add up all of your monthly debt payments; this includes credit cards, auto and mortgage loans, personal loans, and student loans. Then, divide this number by your gross monthly income and you will accurately calculate your DTI.

Here is an example of a DTI calculation:

Total monthly debt obligations: $2,550

Total gross monthly income: $6,000

Debt-to-income ratio = 2,550 / 6,000 = 42.5 %

Of course, upon calculating DTI, a common next step is to understand what your ratio means – is it low or is it high?

What your DTI Ratio Means

Generally speaking, 43% is the maximum DTI a lender will approve for a qualified mortgage loan. A reasonable DTI is considered under 36%, while most consumers feel more financially comfortable around 30%.

There are many reasons why we should have some debt. In fact, a reasonable amount is healthy – providing more buying power in the marketplace. However, a high DTI can affect you in more ways than one.

1. You may have issues getting loans

Even if you have a great credit score, a high DTI may hinder you from being approved for even small loans. This is because lenders want to ensure you can easily afford monthly payments before they extend credit to you.

2. You may be financially stretched

With a high DTI, you may find yourself living paycheck-to-paycheck. Moreover, each paycheck is carefully budgeted, with little room for unexpected expenses.

3. If you lost your income, you could ruin your credit

Because those with high DTI have high monthly bills and a tight budget, those in that financial position could become quickly unable to make payments upon loss of income. This means missed payments and dings on credit. The lower your monthly bills, the easier it is to survive if the unthinkable were to happen.

For this reason, it is very important to have an established emergency fund. Emergency funds are the best way to ensure you have the funds you need when life gets a bit out of control. Be it a medical emergency or a layoff, be prepared for life by saving each month.

Looking to lower your DTI?

Lower your DTI by decreasing the amount of credit you use and by paying off your debt as you are able. Student, auto, and mortgage loans are harder to payoff, so refinancing is the best option if these monthly payments seem too high. Focusing on paying off credit cards and personal loans is usually easier and more appropriate as these loans also tend to have higher interest rates.

Resources

Turbo DTI Monitoring

Understanding LTV

A Guide to Auto Refinancing

About The Author


Julia Guardione

Julia is the resident content creator at RateGenius. She is a graduate of Texas State University and a lover of all things outdoors. She lives in Austin, Texas with her dog and cat. She’s always open to new ideas, so if you have any suggestions or questions, email her at pr@rategenius.com.


Read More

by Julia Guardione

It’s true: multiple credit inquiries can count as one

Credit inquiries can dock your score by multiple points, but they’re a necessary evil if you’re trying to open a new line of credit. Luckily, there are times where multiple inquiries will combine to count as only one. Any time you apply for a new credit-based product, such as an auto loan, credit card, or…

by Rate Genius

What’s a Lease Buyout Car Loan?

When leasing a car, truck, or SUV - dealers give the option to "buy out" the vehicle at the end of the lease contract. This lease buyout is set at the vehicle’s residual value. Why is it a good idea to buyout a lease? You can avoid paying annoying "end of lease" fees and charges.…

by Julia Guardione

The Fed issues first interest rate cut in a decade

The Fed's role is to maintain stability and "alleviate crises" in our financial system. Historically, they have issued rate increases to stabilize a booming, lending-heavy, high-inflation…

review review

Customer Reviews

Read our 10814 Certified Reviews

4.9

READ OUR REVIEWS
apply now apply now

Apply Now

Lower your interest rate and drop monthly payments by an average of $76*/month!


GET STARTED