How To Calculate Debt-to-Income Ratio in 4 Steps

Updated January 31, 2023

If you are considering taking out a loan, it’s important to know if you are financially able to take on more debt given your current income and financial obligations. Understanding how to calculate your debt-to-income (DTI) ratio will help you evaluate your overall financial health. Lenders also use the ratio as a factor in whether they approve your loan request.

In this article, we define DTI ratio and show you how to calculate yours in four steps.

Related: Learn About Being a Loan Officer

What is debt-to-income ratio?

Debt-to-income ratio is the formula used by lenders to determine a client's ability to pay off a loan given the amount of money they already owe. If your DTI ratio is high, you're less likely to be approved for a loan. This happens when the amount of money you owe in loans or other debts exceeds your income. Your DTI ratio includes:

  • Gross income: Gross income is the amount of money you have before any deductions such as taxes or health care plans.

  • Debt: Debt is the amount of money you owe. For example, you may be making payments toward debt on a car loan, home loan, student loan or mortgage.

Once you understand both gross income and debt, you can begin to calculate your DTI ratio.

Related: Gross Pay vs. Net Pay: Definitions and Examples

Why is DTI ratio important?

Your debt-to-income ratio helps determine whether you qualify for a loan. It also gives you an idea of where you stand financially. If you owe a lot of money and don't make enough money to cover it all, your DTI ratio will be high. Knowing your DTI ratio can help you make cost-cutting decisions to help alleviate some of your debt in the future.

How to calculate DTI ratio

Calculating your debt-to-income ratio will help you and potential lenders determine your financial standing. To perform this calculation, you need to know your gross income and how many monthly debt payments you're making. For example, your rent, student loan payments or child support payments would fall into this category. Use these to calculate your DTI ratio with the following steps:

1. Find your monthly gross income

Your monthly gross income refers to the amount of money you make before taxes or other deductions. Use your paycheck as a source of information. If you are paid hourly rather than monthly, multiply the hourly rate by the number of hours you worked in a given week and multiply it by 52 to calculate your annual gross income. Now, take this value and divide it by 12 (the number of months in a year). This will result in your monthly gross income.

Example: Your hourly rate is $20 and you worked 40 hours per week. Multiplying 20  by 40 equals $800. Next, multiply $800 by 52 to get $41,600. This is your annual gross income. To get your monthly gross income, divide $41,600 by 12. This results in a monthly gross income of approximately $3,467.

$20 x 40 = $800

$800 x 52 = $41,600 (annual gross income

$41,600 / 12 = $3,467 (monthly gross income

2. Add up your monthly debt payments

Once you've determined your monthly gross income, you can focus on your monthly debt payments. This is the money that's taken out of your paycheck each month. Expenses like groceries and utilities generally are not included. Once you've figured out all of your monthly debts, take the sum of each value. 

Example: You owe $1,000 in rent, $300 in student loans and $100 for a credit card payment. You would then add 1,000, 300 and 100. This would result in monthly debt payments of $1,400.

$1,000 + $300 + $100 = $1,400

3. Divide your debt payment by your gross income

Now that you've determined your monthly gross income and your monthly debt payments, divide your monthly debt by your gross monthly income: 

monthly debt payment total / gross monthly income = debt-to-income ratio

Example: Divide your monthly debt payment total of $1,400 by your gross monthly income of $3,467. This would result in a debt-to-income ratio of 0.40.

$1,400 / $3,467 = 0.40

Read more: How Do I Calculate My Debt-to-Income Ratio and Why Is It Important?

4. Turn it into a percentage

Once you've calculated your debt-to-income ratio, you'll need to turn the value into a percentage:

DTI ratio x 100 = debt-to-income ratio percentage

Example: Multiply the debt-to-income ratio of 0.40 by 100. This results in a debt-to-income ratio percentage of 40%. This would be considered a high debt-to-income ratio because lenders tend to prefer borrowers who have a debt-to-income ratio smaller than 36. The lower the DTI, the less risky you are to lenders.

0.40 x 100 = 40

DTI calculation example

To get a deeper understanding of debt-to-income ratio calculation, consider the following example:

You are interested in applying for a home loan. Before doing so, you'd like to determine your debt-to-income ratio to determine your odds of getting approved. You've gathered your financial documents and have determined that your monthly gross income is $5,000. After adding together your monthly debt payments, you've determined that you owe $2,000 every month. Once you have these two values, you can begin your calculation.

First, divide your monthly debt payment by your monthly gross income. In this case, you would divide $2,000 by $5,000. This results in a debt-to-income ratio of 0.4. You'd then multiply 0.4 by 100 to get 4% as your debt-to-income ratio percentage. Ultimately, it's up to your lender whether you will be approved for a loan. Since this ratio is higher than they typically consider, you might not qualify.

Frequently asked questions

What factors impact DTI?

Lenders usually consider two components when they figure DTI ratios. They include: 

  • Front-end ratio: This ratio, also called the housing ratio, shows what percentage of your monthly gross income goes toward housing expenses, such as monthly mortgage payments, property taxes, homeowners insurance and homeowners association dues.

  • Back-end ratio: This ratio shows what portion of your income is needed to cover monthly debt obligations, your mortgage payments and housing expenses. This includes credit card bills, car loans, child support, student loans and any other revolving debt that shows on your credit report.

Other monthly bills and financial obligations such as utilities, groceries, insurance premiums, health care expenses, day care, etc., are not part of this DTI calculations. They are not factored into a lender’s decision to lend your money.

What is the DTI preferred by lenders?

The maximum DTI ratio varies from lender to lender. Lenders generally may set a front-end ratio at no more than 28% and the back-end ratio at 36% or lower. 

Major lenders often use the following guidelines for DTI ratios:

  • 35% or less: This ratio reflects that your debt is manageable and you likely will have money remaining after paying monthly bills.

  • 36% to 49%: Your DTI ratio is adequate but you have room for improvement. Lenders might ask for other eligibility requirements.

  • 50% or higher: The ratio reflects that you may have limited money to save or spend. As a result, you won't likely have money to handle an unforeseen event and will have limited borrowing options.

However, depending on your credit score, savings, assets and down payment, lenders may accept higher ratios depending on the type of loan you're applying for. Keep in mind that the lower your DTI ratio, the better your chances of being approved for a loan.

How can you lower DTI?

Here are some tips to help pay down debt and lower your DTI ratio:

  • Create a budget: A budget will help you track your spending. Reduce unnecessary spending to you have more funds to pay down debts.

  • Map out a plan: You might consider reducing debt by paying down either a small credit balance or a balance with a higher interest rate first. After that, move on the next balance. No matter what way you choose, the key is to stick to your plan. 

  • Make debt more affordable: Look into ways you might lower rates on high-interest credit cards. You might call your credit card company to see if it can lower your interest rate. Another option is consolidating credit card debt by transferring high-interest balances to an existing or new card that has a lower rate. Taking out a personal loan is another way you may consolidate high-interest debt into a loan with a lower interest rate and one monthly payment to the same company.

  • Avoid taking on more debt: Avoid large purchases on your credit cards or new loans for major purchases. This is especially important before and during a home purchase. Not only will taking on new loans drive up your DTI ratio, it may hurt your credit score. 

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