Your Debt-to-Income (DTI) ratio simply shows how much of your income goes to debt each month, which is a big clue about your financial health.
Knowing your DTI right now is especially useful as you plan for the year’s end and maybe even get into planning for holiday spending. That’s because it helps you see if your finances are in good shape or need to watch your spending. We’ll explain in detail what DTI is, why it’s important, how to calculate yours easily, and give you clear steps to make it better.
What is a debt-to-income (DTI) ratio?
Your Debt-to-Income (DTI) ratio is a simple percentage that shows how much of your total monthly income you’re using to pay off your debts. Lenders like to look at your DTI because it helps them figure out how risky it might be to lend you money. A lower DTI usually suggests you have more income available to handle new debt payments.
Why your DTI ratio matters
It impacts your loan and credit approvals
When you’re looking to borrow money, your DTI is a big factor lenders consider. For mortgages, a lower DTI suggests you can comfortably handle monthly payments, boosting your approval chances and potentially leading to better interest rates. Similarly, for auto and personal loans, a healthy DTI increases your likelihood of approval and favorable terms. Even when applying for credit cards, especially those with higher limits, lenders use your DTI to assess your ability to manage additional debt.
It shows your overall financial health
Your DTI gives you a snapshot of how much of your income is tied up in debt. It reveals how much money you have remaining for essential expenses like groceries and bills, as well as crucial savings. A high DTI can signal that you might be financially overstretched, leaving you with less flexibility to handle unexpected costs.
How to calculate your DTI ratio
Your DTI can be calculated using this formula: (total monthly debt payments / gross monthly income) x 100
Here’s a more detailed breakdown:
- Total your monthly debt payments: This includes all recurring debt payments, such as mortgage or rent, student loans, car payments, minimum credit card payments, personal loans, and alimony or child support payments. Do not include expenses like utilities, groceries, insurance premiums, etc.
- Total your gross monthly income: This is your total income before any taxes or deductions are taken out. Include your regular salary or wage, any income from self-employment, income from investments, and any other regular income you receive
- Calculation: Divide your total monthly debt payments by your gross monthly income and multiply the result by 100 to express it as a percentage.
Understanding good vs. bad DTI ratios
Think of your DTI like this: If it’s under 36%, you’re generally in good financial shape and borrowing money should be okay. Between 36% and 41% is still decent, but you might want to pay down some debt before taking on more. If your DTI is between 41% and 45%, you’re getting close to having too much debt, and it might be harder to get new loans without reducing what you owe. If it’s over 50%, you might face real financial struggles and could need help getting out of debt. Just remember, these are general guidelines, and different lenders might have slightly different rules.
How to improve your DTI ratio
To improve your DTI ratio, focus on either decreasing your monthly debt payments or increasing your gross monthly income, or ideally both.
Strategies for reducing debt include prioritizing high-interest debts, exploring consolidation options (like a debt management program), or calling a non-profit credit counselor. They can offer advice and help find a debt relief strategy that will work for you.
Final thoughts
Your DTI isn’t just for lenders – it’s a simple way for you to see how healthy your finances are. Knowing your DTI helps you make smart money moves now, whether that’s planning for expenses, paying down debt, or finding ways to earn more. Think of your DTI as your personal financial check-up, helping you feel more confident and in control of your money, not just for the holidays, but for the future.
