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While your credit score is key (particularly when it's low), it’s not the only financial metric you should focus on. If you're managing debt, for instance, being aware of your debt-to-income ratio is crucial. It impacts not just your ability to secure loans, but also serves as a valuable indicator of your overall financial well-being.
What Exactly Is Your Debt-to-Income (DTI) Ratio?
Simply put, your debt-to-income ratio is the comparison of the debt you owe to your gross monthly income. Unlike your credit score and report, which don’t include your income in relation to your debt, your DTI ratio gives a clear picture of this relationship.
DTI provides a more complete view of whether you're living within your means by showing a true representation of your monthly debt obligations compared to your income,” explains Erin Lowry,
author of Broke Millennial.
“While your credit score is an important part of your financial profile, it doesn’t capture the whole picture. For instance, it's possible to carry significant debt and still have a good credit score.
If your DTI ratio is on the higher side, lenders might hesitate to offer you credit or loans, or they may provide you with less favorable interest rates, even if your credit score is strong. This might not be a concern if you're not applying for a loan or credit card, but it’s still wise to keep your DTI ratio in check. A higher ratio means more difficulty in managing and repaying your debt.
Steps to Calculate Your DTI Ratio
Calculating your DTI ratio is quite simple, but there are also online tools available that can automatically do the work for you and even track it over time. For instance, Intuit’s new Turbo app not only helps monitor your credit score but also tracks your DTI ratio, offering tailored advice. If you're a user of TurboTax or Mint.com, you can easily sign in to access Turbo's features.
Bankrate offers a helpful DTI ratio calculator, as well. However, if you'd like to calculate it manually, the process is straightforward:
The DTI ratio is calculated using a simple formula. Take your monthly debt obligations, divide them by your gross monthly income, and then multiply that number by 100,” explains Lowry, who partnered with Turbo.
For example, imagine you have $200 in monthly student loan payments, $850 for rent, and $120 for your car loan. Your monthly gross income amounts to $3,500.
($200 + $850 + $120) ÷ ($3,500) = 0.3342, then multiply by 100 to get 33.42%
When you apply for a mortgage, take into account not only your DTI ratio but also your household ratio (also known as the back-end ratio). The household ratio measures the proportion of your income spent on home-related expenses like property taxes, mortgage payments, insurance, and more.
“Mortgage lenders typically consider both types of DTI ratios, but the back-end ratio is often more significant because it includes your entire debt load,” says Nerdwallet says.
The “Ideal” Debt-to-Income Ratio
Ideally, you want to keep your DTI ratio at or below 36%, says Lowry. This is a typical benchmark that lenders use when assessing your creditworthiness. According to Nerdwallet, mortgage lenders generally prefer a household ratio that’s even lower.
Lenders often focus on the back-end ratio for conventional mortgages, which are loans provided by banks or online mortgage lenders, rather than government-backed programs,” they explain. “If your front-end DTI is under 28%, that’s ideal. If your back-end DTI is below 36%, that’s even better.
Of course, if your goal is to be completely debt-free, a DTI ratio of 0% is the ultimate target. Regardless, it’s another important number to track, in addition to your credit score.
