November 21, 2017

How to calculate your debt-to-income ratio

Jordan Linville

In MortgagesAdvertiser Disclosure

How It Works

In addition to knowing your approximate credit tier, it is very helpful to know your debt-to-income ratio (often abbreviated as “DTI”) when looking at taking on a new loan or mortgage.  Talking about ratios may sound scary, but it is really easy.  You can do it.  Just write down these numbers:

1. Debt: The approximate amount of money you pay on debt each month
   • This includes monthly payments you make on:
     • Mortgage
     • Car payments
     • Credit cards
     • Student loans
     • Personal loans
     • Child support/alimony
   • Do not include rent, utilities (electric, gas, trash), cell phone bills, or credit cards that you pay off every month

2. Income: The approximate amount of money you receive each month after taxes
   • This is just the sum of your paychecks for the month
   • Include any alimony/child support or government support that you receive
   • If your pay varies significantly each month, take the amount you earn each year and divide by 12

A Quick Example

Let’s say you have a mortgage of $1,600 per month, have a car payment of $200, and have student loans of $64,000.  But on those student loans, you are paying $260 each month.  You also have two credit cards that you spend about $1,500 on each, but you pay it off every month.

You would add up $1,600 + $200 + $260.  This would make your monthly debts $2,060.

Remember, you don’t include the entire $64,000 of student loans – just the $260 in monthly payments.  And you don’t include the credit cards at all because they are paid off each month.  You would only include it if you have interest payments you make on them monthly (and you would only include the interest – not the balance).

In this example, you work two jobs: as a call center operator during the week and a couple nights per week bartending.  Your call center job pays $28,000 per year, but then you receive commission for upsells which add up to another $10,000 per year.  You divide each of these number by 12 (months) to find your average monthly income on each.  For bartending, you make $11 per hour and typically make $200 in tips each week.  Since you work 10 hours per week, that’s $110 per month in bartender pay.  The tips are $200 x 4 weeks for another $800 per month.

So, your debt-to-income ratio looks like this:

Your debt-to-income ratio would be 50.5%.

This is calculated as follows: $2,060 ÷ $4,076  = 0.505 = 50.5%

What It Means

To qualify for a personal loan, you need better than a 50% debt-to-income ratio.   If this person could pay off his car payment (or sell the car and buy a cheaper one), that $200 reduction would bring his debt-to-income ratio down to about 46%.  While this decrease is small, it’s significant because it bring the DTI to less than 50% which could mean a lower interest loan and big savings on the cost of that loan in the long-term.

Also, it’s worth noting that a mortgage requires a debt-to-income ratio of 33% or better.  So here, the person has obviously added debt since taking out a mortgage.  If buying a new house, this person would not be able to purchase a new home until selling the first and paying off its mortgage.

Click here to check out your debt consolidation options based off of your credit score and debt-to-income ratio.