How Do I Calculate My Debt-To-Income Ratio?

When you're trying to get your financial life in order, it's important to know your debt-to-income ratio. This number tells you how much of your income goes towards debt payments each month. Knowing this information can help you make informed decisions about your finances and figure out what strategies will work best for you. So, how do you calculate your debt-to-income ratio? Keep reading to find out!

What is a debt-to-income ratio, and why is it important to know what yours is?

A debt-to-income ratio (DTI) is a number that measures how much of your income goes towards debt payments each month. Your DTI ratio compares the amount you owe in debt to your overall gross income. It is an important indicator of your financial health and can help you make informed decisions regarding your finances and debt management goals. Plus, creditors will use your DTI to determine whether or not to give you a loan, so you should know where you stand.

How to calculate your debt-to-income ratio using a simple formula

Your DTI ratio is a comparison of your monthly debts to your monthly earnings. Thus, to calculate your DTI ratio, you’ll need to add up all of your monthly payments that are related to debt (such as credit cards, mortgages, student loans, etc.) and divide them by your gross monthly income. For example, if your monthly debts total to $2000 and your monthly income is $6,000, then your debt-to-income ratio would be 33%.

Before you calculate your DTI, it is important to understand what counts as debt and what counts toward your monthly income. Your debt will include mortgages, rent, car loans, student loans, and credit card payments but not expenses like utilities, daycare, and car insurance. Your income is the amount you earn each month before taxes and any other deductions; income sources include wages, salaries, tips and bonuses, pensions, and social security payments.

Don't forget this important distinction with child support and alimony: they count as debts if you're the one paying them or income if you're receiving these payments.

Check out this helpful DTI calculator from NerdWallet.

Here's an example calculation of someone’s debt-to-income ratio with their debts itemized on one side and their monthly income itemized on the other side.

Why your debt-to-income ratio matters when it comes to financial health

Your debt-to-income ratio is an important snapshot of how well you're managing your finances. Many lenders use it to evaluate whether or not they should approve you for a loan, and some may even use it to set your interest rates. Your ratio will impact your applications for mortgages, auto loans, and credit cards.

A higher DTI ratio can mean that you're in over your head with debt and might need to look into debt relief options, as this isn't sustainable in the long run. A low DTI ratio can mean you're able to make your debt payments without too much of a strain on your budget and can even potentially take on more debt. Knowing your exact ratio will help you gauge your overall financial standing and your chances of being approved for new lines of credit.

What is a good DTI ratio?

A good rule of thumb is to aim for a debt-to-income ratio of 43% or less. This means that no more than 43% of your gross income should go towards paying off debt each month. It’s important to note, however, that the exact target depends on your individual financial goals and situation.

The following guide can help you evaluate your own debt-to-income ratio:

• 36% and below: You're in a good place. Your debt is manageable, and you shouldn't have trouble getting approved by creditors.
• 37% to 43%: There's room for improvement. You're doing okay, but you should prioritize paying down your debt. A lower DTI will improve your chances to borrow or handle any unexpected expenses. 43% is typically considered the cutoff for getting a qualified mortgage.
• 44% to 49%: This range indicates a high debt load, and you may be struggling to make your monthly payments. At this point, you might want to consider a debt management plan from a nonprofit credit counseling agency.
• 50% and higher: If you're in this range, you're in serious financial trouble and will have a difficult time paying down this level of debt. You should seek professional advice on how to best tackle your debt and ultimately lower your DTI.

Steps you can take to improve your debt-to-income ratio

The best way to improve your debt-to-income ratio is to reduce the amount of money you spend on debt every month and/or find ways to increase your monthly income. You can increase your income in a multitude of ways, from changing job roles or getting a promotion to starting a side hustle. Pay off high-interest debts first, and then work your way down the list. You can also consider consolidating your debts or refinancing them at lower interest rates with longer repayment terms.

Another option is to make more than the minimum payments on your debts each month. This way, you're paying down your principal faster. And whatever you do, avoid taking on more debt.

Working with a credit counselor or financial planner to develop a debt repayment plan can also help improve your DTI ratio and get you back on the right track.

Conclusion

Knowing your debt-to-income ratio is an important step in understanding where you are financially and taking steps to improve it if necessary. With a little bit of effort, you can reach a healthier financial situation and put yourself on the path to financial freedom.

If you have financial concerns, contact Community First Credit Union to learn how we can help.