Your debt-to-income (DTI) ratio is calculated by taking the dollar amount of your monthly debt obligations and dividing it by your gross monthly income. It is expressed as a percentage and can be used by lenders as one of several criteria to determine whether it can issue you a loan approval.
The maximum DTI to get approved varies depending on the lender and type of loan you’re trying to get but having a DTI of 40% or less typically gives you excellent approval odds. You can use the calculator below to determine your DTI ratio quickly.
DTI can be used for many types of personal and business loans. If you’re unsure what type of loan you need, we recommend working with a loan broker like Lendio. It has a network of more than 75 lenders, and you’ll be paired with a dedicated loan specialist to help you choose a loan best suited to your needs.
Example of How to Calculate the DTI Ratio
Based on your monthly debt obligations and your gross monthly income, below is an example of how to calculate debt-to-income ratio.
The DTI formula is:
Total Monthly Debt Payments
Gross Monthly Income
Monthly Debt Obligations
Homeowner’s Association (HOA) Dues
Auto Loan Payment
Minimum Monthly Credit Card Payments
Student Loan Payment
Total of Monthly Debt Payments
Monthly Income Earned
Gross Monthly Income
(Total Monthly Debt Payments ÷ Gross Monthly Income) × 100
($3,500 ÷ $8,000) × 100 = 43.75%
Debt Payments Included With the DTI Ratio
Not all monthly debt obligations are included with your DTI. While this may vary from lender to lender as well as the type of loan you’re applying for, below is a breakdown of monthly financial obligations that are commonly excluded or included with your DTI calculation.
Front-end vs Back-end DTI Ratios
The figures mentioned above refer to a back-end ratio, which factors in all debts. Some lenders may have a separate requirement for a front-end ratio, which considers only housing payment debts. Examples of common housing costs include mortgage payments, property taxes, homeowner’s insurance, HOA dues, and mortgage insurance payments.
Income Considerations for the DTI Ratio
Lenders will use your gross monthly income when calculating your DTI ratio. The figure used for purposes of your DTI is based on your pretax earnings and also does not factor in retirement contributions or other payroll deductions or withholdings.
Lenders may have various methods to determine what gross monthly income figure to use. Below are common approaches you may see depending on the type of income you are trying to use to qualify for a loan:
- Salaried employment income: This is arguably the most straightforward income for a lender to calculate. If you earn a salary or are paid the same number of hours per pay period, the lender will simply annualize that figure and then divide it by 12 to determine your monthly gross income.
- Nontaxable income: Income sources that are exempt from being taxed may be grossed up by 25%. For instance, if you earn $1,000 per month in nontaxable income, a lender may be able to use $1,250 in calculating your DTI. Some examples of nontaxable income can include child support payments, social security income, and worker’s compensation payments.
- Variable employment income: If your income fluctuates each pay period, lenders typically need to see a 2-year history of receiving this income to ensure that it’s likely to continue. This is also done so that the lender can determine how to average your income earnings for purposes of qualifying you for a loan. Some examples of variable income can include bonuses, tips, commissions, and overtime pay.
- Rental income from real estate: Lenders will typically review your tax returns and current lease agreements to determine the amount of income to use for purposes of your DTI calculation. Borrowers should be aware that while claiming expenses and other deductions can be beneficial for reducing their tax liability, it can negatively impact the income a lender considers and hurt their ability to secure a loan.
- Self-employment business income: Like rental income, this will often be determined by what you have reported on your tax returns. As a result, it’s important to keep in mind that while claiming certain deductions and expenses can reduce your tax bill, those same items may be deducted from your qualifying income when it comes to getting a loan.
Why Lenders Consider Your DTI Ratio
Lenders view lower DTI ratios more favorably because it shows that a larger portion of your income can be used to service your debt. Depending on the lender and type of loan you’re trying to get, it can be used as one of several factors in determining not only the rate you get but also whether you’ll be approved for a loan.
Other factors that may be considered, which we discuss in greater detail in our guide on how to get a small business loan, can include the following:
- Credit score (see our guides on how to fix bad credit and how business credit scores work)
- Debt service coverage ratio or DSCR (see our guide on DSCR)
- Down payment amount
- Assets and financial reserves available
For other common criteria lenders use, check out our guide to small business loan requirements to help you best prepare for the loan process.
How To Lower Your DTI Ratio
Your DTI ratio is determined by your monthly debt obligations and your gross monthly income. Here are some ways you can reduce your DTI:
- Pay off loans: Paying off loans eliminates those payments from your DTI calculations. Before you do this, however, consider how it may impact your cash flow or financial reserves.
- Refinance debt to lower interest rates or a longer loan term: Refinancing debt to a lower interest rate or longer repayment period can be beneficial since a smaller monthly debt payment will be used in the calculation of your DTI. Before you do this, however, consider the costs associated with the refinance.
- Consolidate debt: Consolidating debt can not only simplify your finances by reducing the number of separate payments that you must make, but it can also reduce your total overall payment amounts. As always, consider the costs associated with a debt consolidation loan as well as the difference in interest rates.
- Renegotiate lease terms: A business that leases its location can renegotiate into a longer-term lease if the landlord is willing to offer a lower lease rate. This can lower the monthly debt obligation for a business. Also, if you have leased equipment that can be bought out or have terms that can be renewed, the ability to pay off your lease or renew it may yield some additional savings.
Frequently Asked Questions (FAQs)
In general, it’s good to have a DTI of 40% or less. However, this will vary depending on the lender you choose, the loan program you’re applying for, and the rest of your business qualifications. For example, if you have strong compensating factors, a lender may have more flexibility to approve you at a higher DTI.
No, the DTI ratio is different from the debt-to-limit ratio. The debt-to-limit ratio, sometimes referred to as credit utilization, measures the amount of credit you are using in relation to the amount that is available to you. For instance, if you have a balance of $500 on a credit card with a $1,000 credit limit, your debt-to-limit ratio would be 50%. Your DTI ratio, on the other hand, compares the amount of your monthly debts against your income.
Yes, some debts may be excluded from the DTI ratio. This will largely depend on whether someone else has been making the payments, whether they are obligated legally as a cosigner on the debt, and how many payments remain before being paid in full. Short-term debts with less than 10 payments remaining, for instance, can often be excluded from the DTI ratio.
The DTI ratio measures the amount of your monthly debt payments against your gross monthly income. It’s used by many lenders to determine whether you can afford the payments on a new loan. Knowing what your DTI is before applying for a loan can give you an idea of your approval odds and the time to pay off debt if necessary.