What is a debt-to-income ratio?

Your debt-to-income ratio is a personal finance measurement that compares your debt to your income and is used together with other indicators to determine your creditworthiness (particularly when buying a house).

Your debt-to-income ratio is calculated by dividing your total monthly debt payments by your gross monthly income, and is written as a percentage. Our debt-to-income ratio calculator makes it easy:

How to calculate your debt-to-income ratio

Use the debt-to-income calculator to find your debt-to-income ratio using your gross monthly income and the sum of your monthly debt payments.

Gross monthly income

“Gross” income is the income you receive before taxes and other payroll deductions. If you know your annual salary, divide it by 12 to find your gross monthly income. You can also find your gross income on your paycheck. If you get paid every two weeks, find your monthly gross income by multiplying your paycheck gross income by 26 and then dividing that number by 12.

Though it may be more helpful for you on a personal level to know what your debt-to-income ratio is based on your net income (your income after payroll deductions), lenders base the ratio on your gross income.

Monthly debt payments

Include all of your fixed monthly debt payments. That includes student loans, auto loans, and your mortgage payment. If you have no mortgage payment, you should insert your monthly rent in this box.

The “minimum credit card payment” refers to the total minimum payments on all credit cards you have balances on. The minimum payment is the payment indicated on your monthly credit card statements.

While it’s common for consumers to pay more than the minimum each month, debt-to-income ratios are calculated based only on the minimum monthly payment.

Finally, there are the “other monthly debt payments”, which is a catchall for all other fixed monthly payments. In this box, you can include non-credit related payments, such as child support or alimony.

Why does your debt-to-income ratio matter?

There are two major reasons you should use the debt-to-income calculator.

Monitoring your debt

A high debt-to-income ratio can be an indication of financial trouble ahead, even if you seem to be easily managing your payments right now.

For example, let’s say your debt-to-income ratio is 50%. Let’s also say payroll deductions are eating up another 20%. That leaves just 30% of your gross income to cover everything else in life. 

With a debt-to-income ratio that high, you may not be in a position to take on an additional obligation, should one arise. Knowing what the ratio is can help you determine the need to begin reducing your fixed monthly obligations. If your debt-to-income ratio is higher than 35%, it might a good idea to start thinking about ways to pay off debt.

Credit applications

Lenders use the debt-to-income ratio as the determining factor in approving new credit. It’s especially important when taking on a mortgage or auto loan.

By knowing what your debt-to-income ratio is before you apply, you’ll have a better chance of knowing whether you’ll be approved. Rather than submitting an application doomed to denial, you can take steps to lower your debt-to-income ratio in advance. In addition to your debt-to-income ratio, your credit score and employment history are critical factors in credit decisions. Before you apply for new credit, check your credit report and scores and work to resolve any issues.

How to reduce your debt-to-income ratio

You can reduce your debt-to-income ratio in three ways:

  • Earn more
  • Pay off debt
  • Refinance existing debt with a lower monthly payment

Earn more

Although earning more money, by itself, does not do anything to reduce your debt, it reduces the percentage of your income that must go to debt payments each month.

For example, if you earn $8,000 per month and have $2,370 in monthly debt payments, your debt-to-income ratio would be 29.6%. If you were to earn $10,000 per month, your ratio would drop to 23.7%

Pay off debt

The second way to improve your debt-to-income ratio is to decrease your debt.

But here’s the catch: DTI is based on your monthly debt payments, not the total amount of the debt. That means if you make extra payments on an auto loan, for example, you are reducing the outstanding balance but your monthly payments stay the same … and so does your debt-to-income ratio.

If you have high credit card balances, making additional payments will improve your debt-to-income ratio because the minimum monthly credit card payments are calculated as a percentage of the outstanding balance.

Conversely, if you increase your debt or decrease your income, your ratio is going to be higher.

Refinancing

You may be able to reduce your student loan payments by refinancing at a lower interest rate or by increasing the number of years over which you repay the loan. While a lower interest rate is a good thing, we don’t recommend refinancing to extend the amount of time it will take you to pay off a debt.

Ironically, however, this move might enable you to get approved for a mortgage when you otherwise couldn’t. Again, it’s because the lending bank only cares about monthly cash flow, not overall debt.

Summary

Money Under 30’s debt-to-income ratio calculator gives you that ratio you really will want and need to know. If you’re getting dangerously close to overspending each month, it can also tell you if you’re likely to get approved or denied by a lender.

It’s for sure a good way to be sure you know where things stand – in case you need to look at the raw numbers and (gulp) hard facts.