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What is debt-to-income ratio?

calculating debt to income
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One thing that lenders will look at when considering lending money, be it for a loan, credit card or mortgage, is your debt-to-income ratio (DTI).

This is a tool that shows not only how much credit you have, but how much of it you are using. This information is then used to lower or improve your credit score.

Essentially, the lower your debt-to-income ratio, the easier it is to keep your finances on track.

This calculation not only provides a snapshot of how you are doing financially, but it gives lenders a good idea as to whether you will be able to cope with any further repayments. For people who have maxed out other lines of credit and have a high debt-to-income ratio, there is a further risk that any other financial commitments would be too much of a burden. This makes rates rocket, as your risk becomes bigger.

What’s a good debt-to-income ratio?

In terms of an ideal ratio, there are various figures but each lender will have their own criteria.

When looking for a mortgage, around 36% has been suggested as the go-to gradient, with around 28% of total debt taken up via a mortgage. 

For home loans, you can often go a little higher, with 43% seen as the golden number, and for debt consolidation that number can fluctuate between 36 and 49%. 

The easiest way to think about the debt-to-income ratio is that debt is part of an income that you have promised to pay, and any future financial lender must take this into account.

Anything above 50% and you are unlikely to become approved and should look for ways to lower your total outgoings.

How do I calculate my debt-to-income ratio?

There are plenty of tools online to work out your debt-to-income ratio, but it is quite simple to work out on your own. Simply divide your combined monthly debt payments by your take-home income and that becomes your percentage figure. 

When considering monthly debts, it’s important to include anything where money has been agreed to be returned on a regular basis. This includes credit cards, student loans, medical payments, car repayments, and mortgages.

As for income, you can include not just your wages but any other income you might make, such as freelance work, alimony, etc. 

For example, if your monthly debts consisted of a $750 mortgage and a $200 car loan with $50 on credit cards, this would total $1000. If your monthly take-home income was $2000 then this would equal a debt-to-income ratio of 50%.

$750+$200+$50= $1000

Divided by $2000 = 0.5

Therefore, the debt-to-income ratio is 50%.

Most importantly, you have to remember that this formula works on repayments only, and not the final balance. So, it might be worth looking at your current terms and adjusting where necessary.

If you are worried that your debt-to-income rate is too high, then it a good place to start is to take a look at your financial outgoings and see where you can save money. 

This can include paying more into your credit card or loan when you are able to, finding cheaper ways to shop, getting a more affordable car, looking to get a debt consolidation loan, and more. Then try and recalculate your debt-to-income ratio once a month to see how fast it falls.

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