6 min read
Spruce
Debt-to-income ratio: Learn how to calculate your DTI
6 min read
Spruce
At a glance
- Debt-to-income ratio (DTI) is a key metric lenders use to assess whether you can afford new debt, comparing your monthly debt payments to your gross income.
- To calculate debt-to-income ratio, add up your monthly debt payments, divide by your gross monthly income, and multiply by 100 to get a percentage.
- Generally, a good debt-to-income ratio below 43% is considered manageable.
Looking to buy a new car or even a new home? That’s an exciting step! But you may be wondering how you’re going to pay for it. For many people, a loan is a necessary part of making big purchases. If you’re new to the process, how lenders decide who to offer credit to can be a bit of a mystery. Luckily, it’s one you can crack.
One important part of the equation: Your debt-to-income (DTI) ratio. It compares how much you owe each month to how much you earn.
Your DTI also helps you and your lender determine if your current debt load is manageable and whether you can afford to take on more. Lenders consider DTI and other financial factors, like your credit score, to determine if another monthly payment likely fits in your budget.
Not sure how to calculate your DTI? Don’t worry, we’ve got you. At Spruce, we’re passionate about helping people get to the bottom of their burning money questions. Let’s dive into this one and we’ll tell you all about the ways Spruce can help make your money management easy.
What is debt-to-income ratio?
Your debt-to-income ratio measures how much of your income goes toward paying your debts. Find this number by adding up all your monthly debt payments and then dividing that total by your gross monthly income. (Gross income is a fancy way of saying your earnings and wages before taxes and other deductions are taken out.)
Understanding your DTI can help you get a better sense of whether your debt payments make up a healthy portion of your income. This question is particularly interesting to lenders. They want to know if with all your current obligations, you’ve got room left over to afford another monthly payment.
The bottom line: In general, the lower your DTI, the better your chances of being approved for a loan.
How to calculate debt-to-income ratio
Your debt-to-income ratio is a measure of your debts compared to your income. It is typically shown as a percentage. Calculating your DTI is less complex than its very official-sounding name might suggest. Here’s how to do it.
- Add up all your monthly debt payments, including mortgage payments or rent if you are renting, car payments, credit card payments, student loan payments, and alimony or child support costs. (You don’t need to include expenses like groceries, utilities, or what you spend on gas.)
- Divide the total amount of your monthly debt payments by your monthly gross income. Again, that’s your income before taxes and other deductions.
- Multiply that number by 100 to express it as a percentage.
For example, say:
- You pay $1,200 a month on a mortgage, $300 for a car payment, and $200 in credit card payments. Add them up and you get a total of $1,700.
- Your gross monthly income is $5,000. So next, divide 1,700 by 5,000, and you get 0.34.
- Multiply that by 100 and you get a DTI of 34%.
What is a good debt-to-income ratio?
Generally speaking, the lower your DTI the better. But the exact percentage you need depends on a few factors, including your income level, your comfort level with managing debt, and what kind of loan you’re considering applying for.
Most mortgage lenders, for example, want to see a DTI of less than 43%. Some prefer ratios below 36%.
Some mortgage lenders will look at how much of your income specifically goes to housing costs. They use a slightly different calculation called front-end DTI. It only includes housing costs such as mortgage payments, homeowner’s insurance, and property taxes. Many mortgage lenders prefer a front-end DTI below 28%. To qualify for a government-backed mortgage loan through the Federal Housing Administration (you might hear it called an FHA loan), you need a front-end DTI of less than 31%.
A DTI below 36% is generally considered a manageable amount of debt, and you likely won’t have trouble opening new lines of credit. Debt-to-income ratios between 36% and 49% may start to raise red flags among lenders.
A DTI of 50% or more indicates a higher debt burden that could hurt your ability to cover other expenses or put money away in savings. If you’ve got a high DTI, consider focusing on reducing the debt you already have.
Keep in mind, too, that DTI is just one part of the equation when it comes to securing a loan. Lenders also consider your income level, credit score, employment history, and assets. If you’ve had trouble building credit in the past, there are also ways to build your credit score, as well as loans available for people with less-than-ideal credit.
DTI and your financial health
You can use your DTI to get a sense of whether your debt is manageable, which is an important part of your overall financial health.
Taking on too much debt can make it difficult to afford other expenses, including necessary budget items like utilities and groceries. It can also make it harder to achieve financial goals, such as saving for an emergency fund. But with the right tools and strategies you can improve your DTI and strengthen your financial outlook.
Consider paying down credit card balances as much as you can or consolidating debt at a lower interest rate. Increasing your income with a side gig or negotiating a raise can boost your income and lower your DTI.
Reducing your spending can also free up more money to put toward debt. If you are worried about your DTI, go through your budget, and look for ways to trim expenses.
Keeping tabs on your credit and spending: How Spruce can help
Tracking your spending, sticking to a budget, and keeping an eye on your credit score are all important parts of managing your debt and keeping your DTI low.
Stay on top of your budget with Spruce’s budgeting tool, which auto-categorizes your spending and allows you to set up watch lists for certain categories. You can also view your credit score anytime under the credit tab in the Spruce app.
These tools can help you stay up to date on important parts of your financial health that can affect your DTI and your ability to get a loan.
Create an account and experience everything Spruce has to offer
Spruce has tools to help you take control of your finances. And with features like the ability to earn 3.50% APY on your savings, fee-free ATMs, and getting paid up to two days early, you know Spruce has your back when it comes to getting better with money.
Get started with Spruce today!
This information is provided for general educational purposes only. It is not intended as specific financial planning advice as everyone’s financial situation is different.
Was this article helpful?
