Debt-To-Income Ratio | Definition, Why It Matters, & Calculation (2024)

FAQs

Debt-To-Income Ratio | Definition, Why It Matters, & Calculation? ›

Your debt-to-income ratio (DTI) is all your monthly debt payments divided by your gross monthly income. This number is one way lenders measure your ability to manage the monthly payments to repay the money you plan to borrow.

DTI Formula and Calculation

The debt-to-income ratio is the percentage of your gross monthly income that goes to paying your monthly debt payments. The DTI ratio is one of the metrics that lenders, including mortgage lenders, use to measure an individual's ability to manage monthly payments and repay debts.

Add up your monthly debt payments (rent/mortgage payments, student loans, auto loans and your monthly minimum credit card payments). Find your gross monthly income (your monthly income before taxes). Debt-to-income ratio = your monthly debt payments divided by your gross monthly income.

Your debt-to-income (DTI) ratio is how much money you earn versus what you spend. It's calculated by dividing your monthly debts by your gross monthly income. Generally, it's a good idea to keep your DTI ratio below 43%, though 35% or less is considered “good.”

From a pure risk perspective, debt ratios of 0.4 or lower are considered better, while a debt ratio of 0.6 or higher makes it more difficult to borrow money. While a low debt ratio suggests greater creditworthiness, there is also risk associated with a company carrying too little debt.

If you own a business, it's important to calculate and analyze the amount of money your company owes in relation to its total assets. In essence, your debt ratio allows you to determine whether or not your company will be able to pay off its liabilities with its assets.

An ideal debt-to-income ratio should be 15% or less. Ratios between 15% and 20% may lead to problems making payments while paying other bills on time. Once debt-to-income ratios exceed 20%, problems with repayment increase dramatically. At this point, seeking help from a trained consumer credit counselor may be needed.

To calculate your DTI, you add up all your monthly debt payments and divide them by your gross monthly income. Your gross monthly income is generally the amount of money you have earned before your taxes and other deductions are taken out.

35% or less: Looking Good - Relative to your income, your debt is at a manageable level. You most likely have money left over for saving or spending after you've paid your bills. Lenders generally view a lower DTI as favorable.

Key takeaways

Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.

How can I fix my debt-to-income ratio? ›

You can lower DTI by decreasing your monthly payment amounts, even if you do not reduce your total amount owed. The easiest way to reduce your monthly payments is to refinance existing loans to lower your interest rate.

The most recent debt payment-to-income ratio, from the third quarter of 2023, is 9.8%. That means the average American spends nearly 10% of their monthly income on debt payments. Despite debt increasing overall, Americans are still spending less of their income on debt than in most of the 2000s.

Generally, a good debt ratio is around 1 to 1.5. However, the ideal debt ratio will vary depending on the industry, as some industries use more debt financing than others.

Lenders use the debt-to-income ratio as a way to measure your ability to manage the payments you make each month and repay the money you have borrowed.

Investors consider the debt ratio as part of their overall risk assessment and investment strategy. Lenders and creditors: Lenders and creditors, such as banks and financial institutions, rely on this metric to evaluate a company's creditworthiness and determine its borrowing capacity.

Ideally, financial experts like to see a DTI of no more than 15 to 20 percent of your net income. For example, a family with a $250 car payment and $100 of monthly credit card payments, and $2,500 net income per month would have a DTI of 14 percent ($350/$2,500 = 0.14 or 14%).

What is an ideal debt-to-income ratio? Lenders typically say the ideal front-end ratio should be no more than 28 percent, and the back-end ratio, including all expenses, should be 36 percent or lower.

Your DTI ratio refers to the total amount of debt you carry each month compared to your total monthly income. Your DTI ratio doesn't directly impact your credit score, but it's one factor lenders may consider when deciding whether to approve you for an additional credit account.

The major benefit of high debt-to-equity ratio is: A high-debt to equity ratio signifies that a firm can fulfil debt obligations through its cash flow and leverage it to increase equity returns and strategic growth.

The debt-to-equity (D/E) ratio compares a company's total liabilities with its shareholder equity and can be used to assess the extent of its reliance on debt. D/E ratios vary by industry and are best used to compare direct competitors or to measure change in the company's reliance on debt over time.