Applying for a new personal loan, auto loan, or mortgage in no small decision. There are important questions to ask yourself. Are you ready to take on a new monthly payment? If so, how much debt can you afford? Dealing with high monthly payments can put a strain on your overall financial health. Luckily, there are measures in place to keep borrowers from getting in over their head. Debt-to-income is one of them.

You already know that your credit score plays an important role in lending decisions. But financial institutions rely on another crucial piece of information: your debt-to-income ratio (DTI). This number allows lenders to assess how well you are managing your current debt, and whether you will be able to take on more debt comfortably. 

Why is the DTI important? 

The DTI measures what percentage of your monthly income already goes towards monthly debt payments. These include existing loan and credit card payments. It also factors in your recurring payments, or recurring monthly debts—mortgage or rent, student loans, child support, alimony, and other personal monthly expenses. 

Research shows that borrowers with a higher debt-to-income ratio tend to have more trouble paying back their loans. These borrowers are overextended financially and considered higher risk. A low debt-to-income ratio shows that you’re managing your debt effectively. 

Calculating your DTI

There’s a simple equation to calculate your debt-to-income ratio. First, add up all of your recurring monthly debt payments. These include: 

• Mortgage or rent 
• Payments on leased or financed cars
• Minimum monthly credit card payments
• Student loan payments
• Personal monthly expenses, including child support, alimony, or other personal loans

You don’t need to factor in living expenses, such as groceries, gas, or utilities. 

Next, divide your monthly debt payments by your monthly gross income. Your gross income is the amount you take home before taxes and other deductions. 

DTI = Monthly Debt Payments / Monthly Gross Income

You can also use an online DTI calculator to figure out your debt-to-income ratio. In general, your DTI falls into one of the following ranges: 

• 0-20%: low risk, you’re likely to be approved for your loan or mortgage. 
• 21-39%: an acceptable DTI, though most lenders prefer less than 36%
• 40% or more: considered high risk. Though some lenders will provide personal loans on a DTI up to 50%, the hard cutoff for many mortgages is 43%.

Importantly, the DTI is a percentage, not a fixed number. It doesn’t matter how much money you’re making. It matters how you’re using that money. For example, an individual making $10,000 a month with $6,500 in monthly debt payments has a 65% debt-to-income ratio. Even though they make more money, they’re less likely to secure a loan than someone who makes $5,000 a month with just $1,000 in monthly payments. A DTI of 20% shows the second person is living within their means and more likely to pay back their new loan. 

Improving your DTI 

Understanding your DTI is an important step in taking control of your finances. If you currently have a high debt-to-income ratio, consider paying down your consumer or educational debt before applying for a new loan or mortgage. You can also contact the team at DEXSTA. Let’s take charge of your financial health.