When you submit a loan application, lenders will typically look at your debt-to-income ratio to determine whether or not to approve your application. Your debt-to-income ratio, or DTI, is your total monthly debt divided by total monthly income. This is sometimes called the back-end ratio, and includes all forms of debt, like student loans and credit cards. Lenders also look at your front-end ratio, or “housing ratio.” Basically, it determines which portion of your income goes to housing expenses, like mortgage payments or property taxes.
Having a lower DTI improves your chances of loan approval, as you’ll show lenders you have the means to pay your loans on time and therefore are more reliable. Calculating your debt-to-income ratio before applying for a loan can help you understand how a lender might qualify your application. Here’s how to do so.
How to calculate debt-to-income ratio
Determining your debt-to-income ratio is done by dividing your total monthly debt by your total monthly income. To calculate your DTI, you’ll first want to start by adding up all of your monthly debts. These will include any debts that are on your credit report, such as car loans, mortgage payments and student loan payments.
After this, you’ll then need to determine your monthly gross income. When applying for a loan, you’ll likely need to have proof of income. Collecting the appropriate tax documents, like your W-2 or business tax returns, can make this step easier.
Once you add up your monthly income and debts, the final step is to divide your expenses by your income. You can then convert this number to a percentage by multiplying by 100. From there, you have your debt-to-income ratio.
What is a good debt-to-income ratio?
While requirements for approval will vary between loan types, a general guideline is to have a debt-to-income ratio of below 36% for a greater likelihood of loan approval.
If your debt-to-income ratio is above 43%, you should work on improving it before applying for a loan because it will be difficult to qualify. Similar to credit scores, a good DTI ratio boosts your chances of approval on auto, home or personal loans.
How to improve your ratio
It seems as though many Americans are having to deal with high debt-to-income ratios. In the first quarter of 2022, the total household debt in the U.S. increased by $266 billion.
If you’re one of the individuals in this position, there are steps you can take to lower your ratio. The most obvious way to do so is to pay down debt. This can be done by increasing monthly payments and avoiding solely paying minimum payment amounts.
Creating a detailed budget can help you cut back in various ways, whether it’s on your internet bill or at the grocery store, and allow you to pay off debts with the extra money saved. Check your DTI regularly to keep track of any fluctuations that occur.