Before you can be approved for a loan, you must have good financial health. In addition to your credit score, debt-to-income ratio (DTI) is an important calculation.
When you apply for credit cards or a home loan, lenders will calculate your debt-to-income ratio to help determine whether you can afford to take on another payment.
Measuring Your Financial Health
As the name implies, your debt-to-income ratio shows how much of your gross income goes to debt payments each month. This number is shown as a percentage with 35% or less showing your debt at a manageable level; 36% to 49% showing that you are managing your debt, but there is room to improve; 50% or more showing that a good portion of your gross income is going towards paying monthly debts.
For example, if you make $64,000 in gross income and your total monthly debt payments are $2,000, your debt-to-income ratio is 38%. This shows lenders that you are managing your debt, but there is room to improve.
Not Taking On More Debt Than You Can Afford
As such, your DTI will help prevent you from taking on more debt than you can reasonably afford. There are two types of DTI that underwriters use to be sure that your monthly debt does not overtake your entire monthly budget:
- Front-end debt-to-income ratio: How much of your gross income goes towards housing costs like utilities, repairs, and maintenance.
- Back-end debt-to-income ratio: How much of your gross income goes towards monthly debts like car and student loans.
Lenders prefer that your DTI not be more than 36%, but if it is below 49%, they will provide you with resources for managing your debt and finding a home loan that is right for youu.
Calculating Debt-To-Income Ratio
DTI is simple to calculate and there are many DTI calculators available online to help you out. To determine your DTI ratio yourself, simply take your total debt figure and divide it by your gross income (income before taxes).