Understanding DTI: What It Is and Why It Matters

If you’re in the market to borrow money (whether it’s a Personal Loan, Auto Loan, or Mortgage), 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, a lender will consider several factors when determining approval. These factors include the applicant’s income, employment history, credit usage, etc. Among these factors is the debt-to-income ratio, or 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.

So, 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, if you’re a renter applying for a mortgage, 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, if you were to apply for a personal loan, the lender would include rent in the calculation, as it’s considered an ongoing monthly expense.

Why does DTI matter?

Why does DTI matter when it comes to getting a loan?

When a lender looks at an applicant’s creditworthiness (their ability to repay a loan comfortably), they use DTI as part of their risk calculation. If too much of your income is earmarked for debts you already carry, the lender can see it as a risk to loan you additional money. In other words, the lender needs to feel fairly confident that the borrower will be able to comfortably repay their debts while still having cash left 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% DTI or lower = excellent
  • 37 – 43% = Good (43% is the maximum allowable DTI for Connexus Mortgage and Home Equity Loans)
  • 44 – 45% = Acceptable

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

How to lower your DTI

If you’re in the market to borrow and are concerned that your debt-to-income ratio could be too high, there are ways to lower it before you apply.

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 smart move 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, allocate a bit more cash towards the principal of any loans or credit card balances. If you have a vehicle payment, look at auto loan refinancing options that might lower your monthly payment amount.

Most importantly, remember that DTI is only one factor in the loan decision process. Connexus members have access to financial wellness services through our partner, GreenPath™ Financial Wellness. If you have concerns about your DTI, take a look at the resources available to you through GreenPath now.