Before getting into the specifics of how to calculate your debt-to-income ratio (DTI), you should know why it’s important and what it’s used for.
One’s DTI demonstrates the amount of debt they are obligated to pay compared to how much available income they have to pay it. It is a calculation that lenders use when considering if you can handle taking on more debt. A desirable DTI is less than 50%. A DTI higher than 50%, indicates that you might be over-extending yourself. To a potential lender, a high DTI signifies that you’d be less likely to regularly make on time payments. A DTI over 50% will likely result in a loan denial. You should know where your DTI stands before going through the lengthy process of a loan application.
So how do you calculate your DTI?
The formula is simple:
Although the formula may be simple, there are a few more things you’ll need to know:
Use your minimum monthly payments for this calculation. For example: if your minimum payment on your credit card is $25, but you usually pay $40/month, use $25 for calculation purposes
DTI does not factor in other expenses such as: utilities, child care, groceries
Some lenders will use your gross income instead of your disposable income for this calculation. Using your disposable income (or take-home pay) will help you err on the side of caution.