When you’re looking to borrow money, it is important that you know your debt to income ratio (also referred to as DTI). To calculate your DTI, you divide your total recurring monthly debt by your gross monthly income. Your gross monthly income is before taxes are deducted. Your debt to income ratio demonstrates to lenders how well you can manage your debts. Lenders tend to look closely at this number when deciding whether to lend you money, and how much.
In looking at your debt to income ratio, the lower the percentage the better:
Below 20% …… excellent
20% – 40% ….. average
40% – 50% ….. stressed
Over 50% ….. danger
How to Calculate[Monthly Debt] / [Monthly Gross Income] = Debt to Income Ratio
The following is an example on how to calculate your DTI:
Monthly gross income: $4000
Mortgage or rent payment: $1000
Student loan payment: $200
Car payment: $500
Credit card payments: $100
Total monthly debt payments: $1800
DTI = [$1800 / $4000] = 45%
In the example above, the DTI was in the “stressed” category. In that case, you would want to either increase your monthly income, or decrease your debt (or both!).
When calculating DTI, lenders look at your gross monthly income. This is because it is more comparable and stable than net income. Depending on your payroll deductions, you could have a very different net monthly income than a colleague, even though you both have the same gross monthly income. Although lenders tend to look at gross monthly income, if you want a truer image of your debt to income ratio, use your net monthly income in the equation instead of monthly gross income.