Understanding DTI: What It Is and Why It Matters

If you’re in the market for a loan, you may have heard the term “debt-to-income ratio” thrown around. Commonly referred to as DTI, your debt-to-income ratio is the amount of debt you carry divided by your income.

This blog post will break down DTI in more detail, provide examples, and explain why it matters when applying for a loan.

What is DTI, and how is it calculated?

When you apply for a loan, the lender will consider several factors when determining approval. Some common factors include your income, employment history, credit usage, and DTI.

In the simplest terms, DTI compares your monthly debt payments to your monthly gross income. Monthly debt payments typically include mortgages, student loans, auto loans, alimony/support payments, and credit card payments.

Here’s an example. Let’s say you have a gross monthly income (“gross” being the amount of money you make before taxes are deducted) of $7,000. To calculate your DTI, you need to add up your monthly debt payments.

In this example, you pay $1,200/mo for your mortgage, $200/mo for a credit card balance, $400/mo for a student loan, and $400/mo for a car payment. This means your monthly debt payments are $2,200.

To determine your DTI, you would divide $2,200 by $7,000 (debt payments divided by gross income). This gets us approximately 0.31. When we turn that decimal into a percent, we get 31%. In this example, you have a 31% debt-to-income ratio.

(Don’t want to crunch numbers yourself? No worries. We have an easy-to-use DTI calculator that will do the math for you.)

Important note: the type of loan for which you are applying matters when calculating DTI.

For example, suppose you’re a renter applying for a mortgage. In that case, the lender will consider your estimated mortgage payment in their DTI calculation but not your current rent payment (as you would no longer have that expense once you leave the rental).

However, the lender would include rent in the calculation if you were applying for a personal loan, as it’s considered an ongoing monthly expense.

Why does DTI matter?

When a lender looks at an applicant’s creditworthiness (their ability to repay a loan), they use DTI as part of their risk calculation. If too much of your income is earmarked for debts you already carry, the lender could see it as a risk to loan you additional money.

In other words, the lender must feel confident that the borrower can repay their debts while still having enough cash each month to cover their other living expenses.

What is a “good” DTI?

There isn’t a one-size-fits-all “good” DTI percentage. Lenders can set their own maximums for their loan products. In addition, certain loans have their own requirements.

Here’s a basic rule of thumb, however:

• 36% or lower = Excellent
• 37 – 43% = Good (43% is the maximum allowable DTI for most mortgage loans)
• 44 – 45% = Acceptable

A DTI near 50% is the maximum for most lenders and loan products. Some loan products may be available at 50% DTI; however, approval will depend on other factors, like a good credit score.

Want to lower your DTI?

If you plan to apply for a loan but are concerned your DTI might be too high, there are ways you can help lower it.

The best and most straightforward option is to lower your monthly debt obligations. Remember, DTI is looking at monthly payment amounts — not total debt. Therefore, debt consolidation can be a smart option as it could lower your monthly payment amounts.

Another option is to consider prioritizing debt repayment before applying for additional loans. As much as possible, stop using credit cards but keep making payments (and pay more than the minimum each month, if you can).

When means allow, put more cash towards the principal of any loans or credit card balances. If you have a vehicle or mortgage payment, consider auto or mortgage loan refinancing options that might lower your monthly payment amount.

Most importantly, remember that DTI is only one factor in the loan decision process. If you have additional questions regarding DTI or any Connexus loan products, you can contact us. Our expert lenders are here to help.