Your debt-to-income (DTI) ratio is the percentage of your monthly income that goes toward paying your debt. It s important not to confuse your debt-income ratio with your credit utilization which is the amount of debt you have relative to your credit limits.
Many lenders, especially mortgage and auto lenders, use your debt-to-income ratio to figure out the loan amount you can handle based on your current income and the amount you re already spending on debt. For example, a mortgage lender will use your debt-to-income ratio to figure out the mortgage payment you can afford after all your other monthly debts are paid.
You, too, can calculate your debt-to-income ratio to figure out how much you re spending debt each month.
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Your debt-to-income ratio is calculated by dividing your monthly income by your monthly debt payments.
DTI monthly debt / monthly income
The first step in calculating your debt-to-income ratio is determining how much you spend each month on debt.
To start, add up what you spend each month on debt, including the following:
Let s assume Sam has the following debt expenses:
Sam s total monthly debt payments $1,540
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The next step to determining your debt-to-income ratio is calculating your monthly income.
Start by totaling your monthly income. Add up the amount you receive each month from:
Remember, Sam spends $1,540 each month on debt payments. This is what he receives in income each month.
Sam s total annual income $3,500 $500 $4,000.
Note: Multiply a weekly income by 4 and bi-monthly income by 2 to calculate your monthly income. Or, if you know your annual salary, divide by 12 to get your monthly income.
Once you ve calculated what you spend each month on debt payments and what you receive each month in income, you have the numbers you need to calculate your debt-to-income ratio. To calculate the ratio, divide your monthly debt payments by your monthly income. Then, multiply the result by 100 to come up with a percent.
In our example, Sam s monthly debt payments total $1,540 and his monthly income total $4,000. So, let s divide $1,540 by $4,000 and then multiply by 100.
$1540 / $4000 .385 X 100 38.5%
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Your final result will fall into one of these categories.
36% or less is the healthiest debt load for the majority of people. If your debt-to-income ratio is within this range, avoid incurring more debt to maintain a good ratio. You may have trouble getting approved for a mortgage with a ratio above this amount.
37%-42% isn t a bad ratio to have, but it could be better. If your ratio falls in this range, you should start reducing your debts.
43%-49% is a ratio that indicates likely financial trouble. You should start aggressively paying your debts to prevent an overloaded debt situation.
50% or more is an extremely dangerous ratio. This means that more than half of your income is going toward debt payments. You should be aggressively paying off your debts. Don t hesitate to seek professional help.
In our example, Sam s debt to income ratio is 38.5%. This isn t a bad ratio, but it could become worse if Sam increases his monthly debt payments without increasing his income.