The Importance of Knowing Your DTI Ratio
You may have heard the term debt-to-income ratio (DTI) tossed around on money management podcasts or by coworkers discussing their plans to buy a new home. Your DTI ratio indicates how the amount of debt you owe compares to your gross, or pre-tax income. The figure is often expressed as a percentage. For this financial score, the lower the number, the better.
Calculating Your DTI
To figure out your own DTI, start by writing down the amount of your recurring monthly debt from each creditor. The list should include any mortgage, auto loan, student loan, minimum payments on credit cards, child support, and alimony. Add up the monthly debt payments on your list.
Next, list the amount of monthly income you receive from each source, including wages, salaries, tips, business income, pension, Social Security, child support, alimony, and other sources. Add up those amounts.
Divide your total monthly debt by your total gross monthly income. This is your DTI ratio. To express the ratio as a percentage, multiply it by 100.
Importance of DTI
Lenders consider DTI a main factor to consider when approving a loan. It helps them assess whether you can afford to borrow more money while repaying your current debt.
The Consumer Financial Protection Bureau (CFPB) recommends a DTI of 43 percent or less if you're considering applying for a mortgage. The CFPB points to research suggesting that borrowers whose DTIs are higher than that are more likely to have problems keeping up with their monthly loan payments.
Apart from its impact on your ability to get a loan, there are other reasons to pay attention to your DTI. For starters, it's linked to how much of your available credit you're using — a factor that accounts for 30 percent of your credit score. It also affects your overall financial stability. If your DTI is too high, it may be difficult to save money, and you may even struggle with basic living expenses.
DTI Is Valuable Info
Knowing your DTI is a good starting point for creating a debt reduction plan. You can lower your number by paying off some of your debt a little faster. Consider adding a bit more to your monthly payments on one or more loans or credit card bills.
Remember that you can also lower your DTI by increasing your income. If you're paying as much as you can afford toward reducing your debt, think about whether you can negotiate a raise or take on a side gig to boost your earnings.
Other options to consider include refinancing a loan or transferring your credit card debt to a lender offering a promotional zero-interest card. Just be sure you won't end up with an even higher DTI because you can't pay off your balance fast enough or you keep adding to your debt.
Knowing your DTI ratio empowers you to set a target for lowering the number so you can raise your credit score and your level of financial stability.