Debt-to-income (DTI) ratio is a measure of your monthly debt obligations in relation to your monthly income. It’s calculated by taking the total dollar amount of your monthly debt payments, and then dividing it by your gross monthly income.
Lenders often evaluate your DTI ratio to determine your eligibility for a loan and how much additional debt you can afford to take on. A good DTI is typically below 40%, but the exact threshold can vary based on the lender and loan program you’re applying for.
DTI Ratio Calculator
If you’re worried that your DTI may make it difficult to get approved for a loan, you can work with a business loan broker like Lendio. It has a network of over 75 lenders, something that can improve your odds of finding a lender willing to issue funding.
Example of How to Calculate Debt-to-Income Ratio
Based on your monthly debt obligations and gross monthly income, below is an example of how to calculate your DTI ratio.
The DTI formula is:
| DTI | = | Total Monthly Debt Payments | × 100 |
|---|---|---|---|
| Gross Monthly Income |
| Monthly Debt Obligations | |
|---|---|
| Mortgage Payment | $1,500 |
| Property Taxes | $750 |
| Homeowner’s Insurance | $250 |
| Homeowner’s Association (HOA) Dues | $100 |
| Auto Loan Payment | $350 |
| Minimum Monthly Credit Card Payments | $150 |
| Student Loan Payment | $400 |
| Total of Monthly Debt Payments | $3,500 |
| Monthly Income Earned | |
| Gross Monthly Income | $8,000 |
| DTI Calculation | |
| (Total Monthly Debt Payments ÷ Gross Monthly Income) × 100 | ($3,500 ÷ $8,000) × 100 = 43.75% |
Debt Payments Included with the Debt-to-Income Ratio
Not all monthly debt obligations are included with your DTI. While this may vary from lender to lender and 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.
Items commonly excluded from your DTI can include:
- Installment loans with 10 or fewer payments remaining
- Utility bill expenses, such as gas, water, and electricity
- Internet and cellphone bills
- Debts that another individual has been making for the past 12 consecutive months
Items commonly included with your DTI are:
- Housing payments on any property you own, including property taxes, insurance, and homeowner’s association dues
- Credit card minimum monthly payments, even if you typically pay the statement balance in full
- Auto lease payments, regardless of number of months remaining
- Other consumer debt, such as auto loans, personal loans, or student loans
- Court-ordered payments, such as child support or alimony
- Deferred installment debt, even if no payment is currently required
- Federal income tax installment payments
- Wage garnishments
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 Debt-to-Income 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 pre-tax 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 non-taxable income, a lender may be able to use $1,250 in calculating your DTI. Examples of non-taxable income 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. Examples of variable income are 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 Debt-to-Income Is Important
Although your DTI ratio is typically evaluated when you apply for a new loan, it can also affect your existing loans. Below are several scenarios that highlight why your DTI is important to monitor. You can also check out our guide on other common small business loan requirements.
Lenders will calculate your DTI ratio to determine if you can afford the payments on a new loan. In some cases, this can be a hard cutoff. If you don’t meet the lender’s stated DTI limits, you can be denied financing, regardless of the other areas of your loan application.
Lenders with flexibility in lending guidelines, however, can sometimes make exceptions if you have compensating factors to offset a slightly higher DTI figure. Common compensating factors include financial reserves, collateral being pledged for the loan, and an excellent credit score.
If you need compensating factors, check out our guide on bad credit and how to fix it.
Your DTI ratio can influence the interest rate you get from a lender. This is because lower DTI figures show that you can allocate a larger portion of your income toward debt repayment, which makes it less likely that fluctuations in revenue would impact your ability to repay the loan.
Loans or credit lines issued by merchants or lenders may sometimes come with the requirement that your credit and finances be evaluated at regular intervals to determine if any changes need to be made to reflect changes to your risk profile. For example, if a lender sees that your debt has increased significantly since the last time it assessed your qualifications, it may decide to increase your rates or elect not to renew your credit line.
Your ability to get a lease for real estate, such as an office building, can be impacted by your DTI ratio. Just like lenders want to see to it that loans issued to you will be repaid, landlords want to ensure that tenants will not default on payments.
If you’re having trouble getting a loan, view the tips we provide in our guide on
how to get a small business loan
.
How to Improve Your Debt-to-Income Ratio
The lower your DTI ratio is, the better it will be for you. Lower DTI ratios will not only improve your chances of getting approved for new loans and leases, but they can also help qualify you for the best rates, fees, and terms.
To lower your DTI ratio, you can either decrease your expenses or increase your income. Below are several ways in which you can get those done.
- 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 and 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. You may also be able to negotiate a better rate on leased business equipment.
Frequently Asked Questions (FAQs)
This depends on the lender and loan program, but a DTI ratio of lower than 40% is usually good enough to get approved for most traditional loans.
Credit cards often report your statement balance and minimum required payment to the credit bureaus, which is what lenders see when they review your credit score and credit report. If you pay off the balance after the statement is issued, lenders will not be aware of that payment as it will not be reflected in your credit report.
Recurring long-term debt reflected on your credit report is generally included with your DTI ratio. This commonly includes mortgages, auto loans, leases, credit cards, credit lines, student loans, and other consumer debt. Wage garnishments, court-ordered debt, and tax payments are also normally included in the calculation of your DTI ratio.
Short-term, non-recurring, and debt paid by others can often be omitted from your DTI ratio. Common examples include loans with fewer than 10 payments remaining, utility bills, and cell phone bills.
In most cases, no. The DTI ratio is calculated by using your gross monthly income, a figure that is not impacted by payroll deductions—such as retirement contributions, taxes, and health benefits. A wage garnishment, however, is one example of an uncommon payroll deduction that can affect your DTI ratio.
Bottom Line
Your DTI ratio can determine whether you get approved for a loan and the rates and terms you will be offered. In some cases, it can also affect the rates on your existing loans. We recommend tracking and managing your DTI regularly as it can help save you money by getting more favorable rates from lenders.
