What it means
Debt-to-income is expressed as a percentage, and a lower number is better. A DTI of 20% means one-fifth of your gross (before-tax) income is already committed to debt repayments, which leaves plenty of room for new borrowing.
A DTI of 50% means half of your income is spoken for before you buy groceries or pay rent. Banks and mortgage lenders lean on this ratio because it is simple and hard to argue with.
A borrower can have a high income and still be stretched if the repayments are large, while a modest earner with few debts can be a very safe bet. The ratio captures that difference in one number.
Lenders usually split DTI into two versions. The front-end ratio counts only housing costs such as the mortgage, property tax and insurance, while the back-end ratio adds every other recurring debt, including car loans, student loans and the minimum payments on credit cards.
When people say "DTI" without any qualifier they normally mean the back-end version. The ratio is not only a personal finance tool.
Small business owners often see it applied to their personal finances when they apply for a business loan, particularly if they are sole traders or have signed a personal guarantee (a promise to repay from their own pocket if the business cannot). Lenders for company borrowing tend to use different measures, such as the debt service coverage ratio.
Acceptable limits vary by lender, loan type and country, so there is no single magic number. As a rough guide, many lenders become cautious once the back-end ratio climbs above the high 30s or low 40s in percentage terms, although some programmes allow more.
Rent, utilities and food are generally not counted as debts, which is why DTI can understate how tight a budget really is.
In practice
Real-world examples.
Example
A first-time home buyer in the property market earns $6,000 a month before tax and already pays $600 a month on a car loan. A lender sets a maximum back-end DTI of 40%, so total debt payments including the new mortgage cannot exceed $2,400, which leaves $1,800 for the mortgage.
Example
A freelance graphic designer applies for a $15,000 equipment loan. Her gross monthly income averages $5,000 and her existing debts cost $1,500 a month, giving a DTI of 30%, so the lender is comfortable and approves the loan.
Example
A restaurant owner personally guarantees a business loan and the bank reviews his personal finances. His earnings of $8,000 a month are offset by $4,400 of personal debt payments, a DTI of 55%, so the bank asks him to pay down a credit line before it will lend.
Formula
Calculation
DTI = (Total monthly debt payments / Gross monthly income) x 100
Worked example: a borrower has a mortgage payment of $1,800, a car loan payment of $400, a student loan payment of $300 and credit card minimum payments of $200 each month.
Total monthly debt payments = $1,800 + $400 + $300 + $200 = $2,700
Gross monthly income = $9,000
DTI = ($2,700 / $9,000) x 100 = 0.30 x 100 = 30%
If the same borrower wanted a new $500 monthly loan, the payments would rise to $3,200 and the DTI would become ($3,200 / $9,000) x 100 = 35.6%, which is a useful way to test affordability before applying.Case study
Seen in the real world.
Maple Grove Dental is a fictional two-chair clinic whose owner, Dr Imani, wanted a $120,000 loan to add a third chair. Her bank looked at her personal DTI because she was signing a personal guarantee. With gross monthly income of $12,000 and debt payments of $5,400, her DTI stood at 45%, above the bank's comfort level.
Rather than give up, Dr Imani paid off a $15,000 car loan that carried a $450 monthly payment using savings. Her payments fell to $4,950 and her DTI dropped to 41.25%. She also provided a signed contract showing extra income from a nearby school programme, which lifted her assessed income to $13,000 and brought the ratio to 38%.
This illustrative story shows that DTI can be improved from both sides of the fraction: reduce the payments on top, or document more income on the bottom. The bank approved a smaller starting loan, and Dr Imani added the chair six months later.
Watch out
Common mistakes.
- Using net (after-tax) income instead of gross income, which makes the ratio look worse than the lender will calculate it.
- Forgetting small recurring debts such as credit card minimums, buy-now-pay-later plans and personal loans, which can add hundreds of dollars a month to the total.
- Assuming that a low DTI guarantees approval, when lenders also check credit history, savings, employment stability and the size of the deposit.
Questions
People also ask.
Is rent included in DTI?
Rent is normally not counted as a debt when you are applying for a loan, although a new mortgage payment replacing the rent would be counted.
What is a good DTI?
Lower is better, and many lenders prefer a back-end ratio at or below roughly 36% to 43%, but the exact limit depends on the lender and the loan type.
How can I lower my DTI quickly?
You can pay off or consolidate small loans, avoid new borrowing before applying, or increase your documented income, for example by adding a co-borrower.
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