What Is Debt-To-Income (DTI) Ratio?
Lenders use the debt-to-income (DTI) ratio to measure their borrowing risk. It is the percentage of your gross monthly income that goes to making your monthly debt obligations.
The debt-to-income (DTI) ratio compares an individual’s monthly debt payment to their monthly gross income. The amount you earn before taxes and other deductions is your gross income, and the debt-to-income ratio is the percentage of your gross monthly income that goes into debt payments each month.
DTI = Total of Monthly Debt Payments / Gross Monthly Incomes
The debt-to-income (DTI) ratio measures how much money a person or organization makes to pay off debt. The most DTI a borrower may have while still qualifying for a mortgage is 43 percent. However, lenders usually prefer ratios of no more than 36 percent.
A low DTI ratio implies enough income concerning debt payment, making a borrower more appealing, and it also displays a healthy debt-to-income ratio. In other words, if your DTI ratio is 15%, it indicates that 15% of your total monthly income is used to pay down debt each month. A high DTI ratio, on the other hand, suggests that an individual has too much debt for the amount of money they make each month.
Borrowers with low debt-to-income ratios are more likely to keep up with their monthly debt payments. As a result, before extending a loan to a potential borrower, banks and financial credit providers typically request to see low DTI percentages. Lenders favor low DTI ratios because they want to make sure a borrower isn’t overextended, which means they have too many loan payments compared to their income.
Debt-To-Income (DTI) Ratio Example
Gabriella is attempting to determine her debt-to-income ratio to obtain a loan. The following are her monthly expenses and earnings: Mortgage: $8000, Car loan: $300, Credit cards: $200, Gross income: $2,600
To calculate DTI for Gabriella,
First calculate her total monthly debt payment which is $800 + $300 + $200 = $1,300
DTI = Total of Monthly Debt Payments / Gross Monthly Income
= $1,300 / $3,900
0.3 x 100 = 30%
So from the calculation, Gabriella’s DTI is 30% which is good enough for her to get a loan.« Back to Glossary Index