What is the Debt-to-Income (DTI) Ratio?

Your debt-to-income ratio is like a scale…

On one side of the scale are your monthly debt payments. On the other is your monthly income. The bigger your income is in comparison to your debt payments, the more the scale will tip to the income side (the lower the ratio, and the better you look to banks). The bigger your debt payments, the more the scale tips toward the debts (the higher the ratio, and the worse you look to banks).

The debt-to-income (DTI) ratio is a measure used by many lenders and banks when they review loan applications. DTI ratios measure your monthly income in comparison to your minimum required monthly debt payments.

To find the ratio, you divide your total monthly loan payments by your gross monthly income. The lower the ratio, the more money you have available each month to spend on things other than paying your debts. The higher the ratio, the larger the portion of your income that you have to dedicate to meeting your obligations.

For example, if you earn $4,000 per month in gross income, have $1,000 in mortgage payments, $400 in auto payments, and $800 in credit card payments, your DTI is:

($1,000 + $800 + $400) / $4,000 = 55%

Generally, lenders prefer to lend money to people with low DTI ratios. The more flexibility a person has in his or her monthly budget, the easier it tends to be for that person to make payments on a new loan.

Having a high DTI ratio can result in lenders refusing to offer you a loan, even if you have strong credit.

The lowest possible debt-to-income ratio is zero, which can happen if you have no debt payments every month. In theory DTI ratios can exceed one, which happens if you have higher debt payments than your monthly income. It’s rare to find a lender willing to give you such large loans, so this typically happens due to a combination of high debt and a loss of income.

For example, using the scenario above, if you lose your job and find a new position that only pays $2,000 per month, your new DTI ratio will be:

($1,000 + $800 + $400) / $2,000 = 110%

Your debt-to-income ratio starts with your gross income, which is all of the money that you make before you subtract out things like taxes, insurance costs, retirement account contributions, or any other expenses.

You then have to find the sum of all of your monthly debt payments. This includes things like:

• Credit card debt
• Student loans
• Auto loans
• Mortgage payments
• Other debts, such as personal loans
• Court-ordered fixed payments, like child support

Some lenders include monthly housing payments, like rent, in the calculation — even though they are not debt payments. When renters calculate their DTI and exclude their rent costs, they may want to aim for a lower DTI than homeowners with a mortgage to account for their higher monthly costs.

Your DTI ratio tells you how much impact your debt has on your monthly budget. A high DTI ratio means that your debt payments take up a significant portion of your monthly income, leaving you with less flexibility in how to spend your money.

A low DTI ratio indicates the opposite. You likely have to dedicate only a small portion of your income to required payments, giving you more freedom to spend money or to save it for the future.

DTI also helps you decide whether you can afford to take on new debt.

You know you need some flexibility in your budget because you have to spend some of your income on necessities like utilities or food, even if they aren’t part of your debt payments. If you realize you already have a high DTI, you know that adding more debt will put significant strain on your budget, so you may decide against it.

Your debt-to-income ratio compares your monthly income and your monthly debt payments.

Your debt-to-limit ratio ignores your income and payments, comparing your debt balance to your total credit limits.

For example, imagine you have three credit cards with the following balances and credit limits:

Your debt-to-limit ratio is:

($2,000 + $0 + $3,000) / ($5,000 + $1,000 + $3,000) = 55.56%

Debt-to-limit ratios only apply to revolving debt, like credit cards, where you receive a credit limit and can borrow money up to that limit.

Your debt-to-limit ratio impacts your credit score, as lenders view people who max out their credit cards as riskier than people who use a smaller proportion of the limit.

Your DTI ratio doesn’t impact your credit score directly, but it does have an impact on your ability to qualify for loans.

The formula to calculate a debt-to-income ratio is:

(Total monthly debt payments / Gross monthly income) * 100 = DTI ratio

For example, if you earn $3,000 per month and spend $800 on minimum debt payments, your DTI ratio is:

($800 / $3,000) * 100 = 26.67%

Debt payments include all of the minimum required payments you need to make on debts. For example, if your minimum mortgage payment is $900, but you pay $1,000 per month to help pay it off early, the number used is $900.

It can get confusing because some lenders include non-debt bills when calculating your DTI. For example, some lenders include your rent payment if you don’t own a home. Others might include things like electric or water bills.

Remember that gross pay isn’t equal to your take home pay. Gross pay is all of the money you make before deducting things like taxes, insurance, retirement contributions, or union dues. Your take home pay will be smaller than your gross income.

Every lender has a different opinion about what qualifies as a good debt-to-income ratio. In general, the lower your DTI, the better, because it means you have to spend less of your income on required debt payments.

Many lenders look for borrowers with a DTI of 35% or below. For lenders that don’t include rent in their DTI calculation, it’s good to aim for a DTI below 20% if you rent.

As with other types of loans, each lender has a different preference for the applicant’s debt-to-income ratio in a mortgage application. However, lower is generally better.

There are some targets you can aim for based on government regulation. For a qualified mortgage (one eligible for purchase by Freddie Mae or Fannie Mac, government entities that buy mortgages from lenders), the maximum DTI is 43%.

If you have compensating factors, such as a great credit score or significant assets that you could use to pay down your loan balance, an exception to the 43% maximum is possible.

The Federal Reserve calculates DTI ratios as disposable income compared to monthly debt payments and found that in 2021, the average household DTI ratio in the United States was 9.00%, down from a high of 13.01% just before the 2008 financial crisis began.

This indicates that the average household spends just under a tenth of its disposable income on required debt payments.

One limitation of the debt-to-income ratio is that it only looks at debt payments. It doesn’t account for other necessary expenses that people face, such as buying food, clothing, or gas for their car. Someone with a reasonable DTI ratio could have high food and transportation expenses, meaning they have far less flexibility in their budget than their DTI suggests.

Another limitation of DTI is that it uses gross income in the calculation. Someone who makes $4,000 per month could pay hundreds of dollars in income tax and other taxes each month.

They also may pay more for necessary costs, such as insurance or union dues. Again, this means that someone with a low DTI ratio may have far less budget flexibility than the ratio indicates.

Debt-to-income ratios are important because they give both borrowers and lenders a quick way to measure budget flexibility and the ability to handle new loans.

If someone has a high debt-to-income ratio, they know that they do not have much flexibility with their budget. Most of their income must go toward paying monthly bills. If they stop making those debt payments, they will likely default on the loans, incur heavy fees, and damage their credit.

DTI is also important because many lenders use it when making lending decisions. Lenders know that people with high DTI ratios don’t have much budget space to handle new monthly payments.

If an applicant’s DTI is too high, the lender knows that the borrower may not be able to make his or her payments, and the lender won’t approve the loan.