Debt-to-income Ratio: What It Is & How To Calculate Yours
When shopping for a mortgage, one of the things that lenders will look at is your debt-to-income ratio. If this ratio is too high, it may keep you from getting approved. Don't take any chances — know your debt-to-income and take steps to keep it at a healthy level.
Recently, I had a conversation with a friend who was trying to refinance her app德扑圈官方网址home. Two different lenders denied her because her debt-to-income ratio, or DTI, was too high. My friend was frustrated and asked me why this happened and what her debt-to-income ratio actually was. More importantly, she wanted to know how to reduce her debt-to-income ratio.

Your debt-to-income ratio, explained

Your debt-to-income ratio is a personal finance measurement that compares your debt to your income and is used together with other indicators to determine your creditworthiness (particularly when buying a house).

Your debt-to-income ratio is calculated by dividing your total monthly debt payments by your gross monthly income, and is written as a percentage.

Example: Let’s say my friend’s total recurring monthly debt payments were composed of: 

  • $1,000 housing payment (including mortgage, PMI, and taxes)
  • $600 car payment
  • $200 car payment
  • $220 credit card payment
  • $350 student loan payment

for a grand total of a $2,370 in monthly debt payments. Let’s also say her gross monthly income is $4,000. This means her debt-to-income ratio would be $2,370/$4,000, or 59 percent.

A debt-to-income ratio of 59 percent is high, and my friend would have a hard time getting a loan (or refinancing) without changing something.

Calculate your debt-to-income ratio:

How to change your debt-to-income ratio

You can improve your debt-to-income ratio in three ways:

  • increase your income
  • pay off debts
  • refinance existing debt with a lower monthly payment

Increasing income

Increasing your income affects the ratio like this:

Example: If my friend had the same amount of debt ($2,370) but a gross income of $8,000 per month, then her debt-to-income ratio would be 29 percent ($2,370/$8,000=0.29625).

Paying off debts

The second way to improve your debt-to-income ratio is to decrease your debt. If my friend paid off one of her car loans, then she would have less debt and a better ratio.

But here’s the catch: DTI is based on your monthly debt payments, not the total amount of the debt. That means if you make extra payments on an auto loan, for example, you are reducing the outstanding balance but your monthly payments stay the same … and so does your debt-to-income ratio.

If you have high credit card balances, making additional payments will improve your debt-to-income ratio because the minimum monthly credit card payments are calculated as a percentage of the outstanding balance

Conversely, if you increase your debt or decrease your income, your ratio is going to be higher.

Refinancing

You may be able to reduce your student loan payments by refinancing at a lower interest rate or by increasing the number of years over which you repay the loan. While a lower interest rate is a good thing, we don’t recommend refinancing to extend the amount of time it will take you to pay off a debt.

Ironically, however, this move might enable you to get approved for a mortgage when you otherwise couldn’t. Again, it’s because the lending bank only cares about monthly cash flow, not overall debt.

Related: Buying a app德扑圈官方网址home, even if you have big student loans

The takeaway

Regardless of whether it is high or low, there is value in knowing your debt-to-income ratio. If your ratio is high, it can take some time to decrease it. The sooner you know, the sooner you can implement a plan. If your ratio is low, this means you should have an easier time getting approved for a mortgage or a refinance. Either way, there is power in knowing.

Related: How to find the best online mortgage lenders

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About the

Total Articles: 18
Natalie Bacon is the blogger behind Financegirl, where she writes about finance and intentional living for young professional women. Natalie is a former corporate attorney who traded in her job to pursue a career in financial planning, freelance writing, and blogging.

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3 comments
Kim Strand says:

The debt to income has continually been a problem. I have multiple debts that are my company’s secured debt and paid for by my company. Whatever software the mortgage loan officers and underwriters use does not ‘understand’ that those bills are paid for by the company.
They continually mark them in my personal debt/income ratio. I have explained these debts are reported and calculated on my schedule C taxes as company debts. Only 1 loan officer understood this, and said as long as I provide a business bank statement showing my company paid these bills they could be taken out of the D/I.
Why do most loan officers not understand this information? How can I find banks/ or loans products that exclude secured payments or business debts?

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Chella says:

I must admit that I was totally oblivious of this aspect of Debt-to-Income ratio. I think it was the most likely reason a close friend of mine failed to get a loan at a certain macro finance entity. She was servicing a lot of loans at that time including her students loan. i have learnt something new on reducing the ratio i must say. i will try paying off some little debts i have here and there and also strive to increase my income.

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Chris Muller says:

Really great piece Natalie, I agree D/I is important. I was a credit analyst for a F500 bank and we focused heavily on the D/I ratio. After a certain threshold (in my experience, we got nervous at anything over 30%, but I’d consider 20% the limit) we would look to reduce credit lines or shut down lines of credit entirely. Lastly, some banks actually exclude secured debts when looking at the D/I ratio (depending on the product you’re applying for or that’s being reviewed) – so things like mortgage payments or student loans (not “secured” but not “unsecured” either) might not be counted. Just a thought.

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