Debt-to-Income Ratio: What it is and How to Calculate it

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To get a loan, you need to prove you can pay for it.

That might seem a bit counterintuitive. “If I could pay for it, why would I be borrowing in the first place?” you ask.

But lenders aren’t in the business of giving away money to just anyone, so they want proof that you’re a responsible person who has the ability to pay back your debts.

One way to do that is by checking your debt-to-income ratio, or DTI.

That’s the ratio that compares your monthly debt payments to your monthly income. Essentially, if you’re already handing over most of your paycheck to cover other debts, your potential lender may think you won’t have enough left over to pay back the new loan.

If you’re in the market to buy a house or car, your DTI could play a big factor in deciding whether you’re approved, for how much and at what rate. 

Wondering what your DTI is and what’s a good score? We can help.

What Is Debt-to-Income Ratio?

Here’s the thing about a DTI ratio: The number can vary depending on who’s doing the figuring. Don’t worry — we’ll explain.

How to Calculate DTI

Here’s the basic formula for a debt-to-income ratio:

DTI = Monthly debt obligations/Monthly pay

Simple enough, right? But what goes into your monthly debt? And how about your monthly pay? 

If you’re calculating DTI simply for your personal budgeting purposes, you’re better off using your net monthly pay (the amount you get in your paycheck after taxes and withholdings) since that’s the money you actually have to pay off your debt. That DTI ratio is commonly known as consumer DTI.

But the overall DTI — the one lenders prefer — uses your gross monthly pay (your pre-tax pay). 

Why? Because it’s a more stable number that isn’t susceptible to month-to-month changes depending on your withholdings — plus it’s typically easier to get this information from a borrower quickly (divide your annual salary by 12).

OK, so the bottom number (aka divisor) is easy enough. The top half of the ratio (aka numerator) is a little trickier. 

For your overall DTI, you should only include monthly payments for debts — not ongoing expenses, according to Bruce McClary, vice president of communications for the National Foundation for Credit Counseling in Washington, D.C. Those debts could include credit cards, auto loans, student loans and installment payments for medical bills.

Pro Tip

Although you may (and should!) pay more on your credit cards, for purposes of calculating your debt-to-income ratio, use the minimum monthly payment.

Your overall DTI ratio does not include monthly expenses such as groceries, gas and utilities.

“The golden rule is only to include things that show up on the credit report,” McClary said. 

However, that raises the question of whether you should include your rent, which is technically not a debt. 

If you’re calculating your DTI strictly for personal planning, you should include it as part of your expenses. But will lenders include it? That depends, according to Brent Weiss, CFP and chief evangelist of Facet Wealth.

“If your lease is ending, or is month-to-month, you may have more flexibility with the lender,” he wrote in an email. “But the lender will still want to know what your monthly expenses will look like going forward.”

If you’re applying for a mortgage, the lender may also factor in something called your front-end DTI, which only compares your housing expenses to your income. That number will include your current mortgage or rent unless you can prove that your obligation to make payments will end at a specified date (if you’ve completed a contract for selling your house, for instance). 

For example:

Jane wants to buy a house and applies for a mortgage. Each month, she pays $1,200 in rent (her lease ends next month), $400 for her auto loan, $600 in student loans and $100 toward her credit cards. Her gross monthly income is $3,500; her net monthly pay (after taxes and withholdings) is $2,600.

Consumer DTI

To figure her consumer DTI ratio (for Jane’s personal financial planning purposes):

$400 auto loan + $600 student loans + $100 credit cards + $1,200 rent = $2,300/$2,600 net pay = .88 x 100 = 88%

Front-end DTI

To figure Jane’s current front-end DTI ratio (housing expense):

$1,200 rent/$3,500 gross income = .34 x 100 = 34%

Overall DTI

To figure her overall DTI ratio (the lender doesn’t include her rent because her lease ends next month):

$400 auto loan + $600 student loans + $100 credit cards = $1,100/$3,500 gross income = .31 x 100 = 31%

If Jane was midway through a 30-year mortgage instead of nearing the end of her lease, her overall DTI ratio would be:

$400 auto loan + $600 student loans + $100 credit cards + $1,200 mortgage = $2,300/$3,500 income = .66 x 100 = 66%

Why Your Debt-to-Income Ratio Matters

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Although the consumer and housing DTI are helpful indicators for your personal financial health, the overall DTI is the one you should have your eye on if you’re trying to get a loan.

“Overall DTI is the most important debt ratio that lenders use” Weiss wrote. “This combined with your credit score will determine if you can qualify for a loan and how favorable the terms will be.”

Lenders generally view consumers with higher DTI ratios as bigger risks since more of your income is going to pay off current debt. That means even if you’re willing to pay for the pricier car or house, lenders might side with hard numbers as proof of your inability to pay and approve you only at higher interest rates — or deny the loan altogether.

If you noticed, the above statement said “generally” and “might” — those qualifiers are important, because every lender uses its own formulas to determine eligibility. 

That’s particularly true when factoring in student loan debt, as there are lenders who’ll make exceptions for applicants with higher student loan balances who manage to keep up with their debt obligations, according to McClary.

[Overall DTI] combined with your credit score will determine if you can qualify for a loan and how favorable the terms will be.

“Debt-to-income ratio guidelines depend on the type of loan that you’re getting, and in some cases those guidelines may vary from lender to lender,” he said. “Ask a lot of questions about what the guidelines are and whether [the lenders] can make exceptions for student loan debt and other circumstances.”

Additionally, depending on the lender, other factors may be considered when deciding whether you can meet loan qualification requirements.

“Oftentimes, exceptions can be made if you have a credit score that’s in the top 1 percentile, if you have a very clean credit history and if you demonstrated that you’re reliable in repaying your debts,” McClary said. 

It’s one of the many reasons you should shop around for lenders before accepting any offers. 

What’s a Good Number?

So you know what your numbers are, you know why they’re important, now for the important question: What are the numbers you need?

“The numbers that many consider ‘good’ are 25%, 35% and 43% for housing, a healthy level of debt, and maximum DTI for lenders, respectively,” Weiss wrote. “Keep in mind, these are all rules of thumb.”

McClary agreed that while an overall DTI of 43% is typically the upper limit for lenders, the lower you can get your number, the better.

“It’s the same rule that applies on the open highway: If you’re driving right at the speed limit, your foot might get heavy and you might go over,” he said. “So that may look a little bit riskier than somebody driving 10 miles below the speed limit — or 15. 

“But I can’t pin down a specific number below 43 and say, ‘That’s the sweet spot.’”  

And when calculating for your own purposes, Weiss noted that rather than using an arbitrary number to decide your debt ratio, you should consider reversing the process and deciding what your debts and income should be based on what your goals are. 

“Most families save what they have left at the end of the month when they should be spending what they have left after saving,” he wrote. “Having a financial plan and knowing how much you want and need to save to achieve your goals will then help guide how much you can comfortably spend month-to-month.” 

How Can You Improve Your Debt-to-Income Ratio?

Although it isn’t the only factor, lowering your DTI ratio can help when you’re applying for a loan. If yours is higher than you’d like, we have suggestions for improving it:

  1. Increase your income.

    Whether it’s asking for a raise at work or taking on a steady side hustle, boosting your steady gross income will lower your DTI ratio.

  2. Decrease expenses.

    Cut your monthly expenses by taking on a roommate or double down on paying off some credit cards using the debt snowball method.

  3. Use rates to your advantage.

    You can also use financial strategies to lower your DTI ratio. By taking advantage of a balance-transfer offer and consolidating loans, you could potentially lower your minimum monthly payment on your credit cards, which reduces your monthly debt obligations.

You should always keep an eye on your DTI ratio, as it helps you track how well you’re managing your debt. Its importance in terms of loan qualification should just be a bonus, according to McClary.

“That’s one less thing you have to worry about,” he said.

Tiffany Wendeln Connors is a staff writer/editor at The Penny Hoarder. Read her bio and other work here, then catch her on Twitter @TiffanyWendeln.