Bottom Line Up Front
- Your DTI or debt-to-income ratio is calculated by dividing your monthly debt payments divided by your gross monthly income.
- DTI is important when you’re considering a mortgage.
- There are ways you can manage or lower your DTI, like reviewing your budget or consolidating debt, and DTI doesn’t impact your credit score.
Your credit report and credit score aren’t the only factors that can impact your ability to borrow money. Another factor you should be familiar with is your debt-to-income (DTI) ratio. It’s a way for lenders to assess your ability to pay back your loans. Here’s how it works and what you can do to improve your DTI ratio.
What’s a DTI Ratio, and Why Does It Matter?
Your DTI ratio is calculated by taking the sum of your monthly debt payments and dividing by your gross monthly income. If you have a low DTI ratio, it means you don’t have excessive debt to pay in relation to your income. A high DTI ratio means a large chunk of your income goes toward paying off debts. This can cause some lenders to see you as a high risk—potentially leading to the rejection of your loan application. Plus, a high DTI ratio can simply be hard to manage without missing payments.
If you’re hoping to get a mortgage soon, you’ll want to be mindful of your DTI ratio. Many lenders aren’t able to offer a Qualified Mortgage unless the borrower’s DTI ratio is 43% or lower. Qualified Mortgages are meant to provide extra protections to consumers and are less likely to result in a borrower defaulting on their loan.
So, if you want to be eligible for a more accessible mortgage with potentially lower rates and fees, you’ll need a low DTI ratio.
Calculating Your DTI Ratio
Here’s what calculating your DTI ratio might look like in real life:
Let’s say you currently make monthly debt payments of $1,200 on rent, $300 on an auto loan, $350 on a student loan and $50 on a minimum credit card payment. In total, that’s $1,900 in monthly debt payments. Note that payments such as utilities and insurance premiums aren’t included—only debts that appear on your credit report.
Next, determine your monthly gross income, which is your pre-tax, pre-deductions income. If you make an annual salary of $48,000, that equals $4,000 per month. Take the $1,900 in debt payments and divide by $4,000. The result is a DTI ratio of 47.5%.
How to Lower Your DTI Ratio
There are 2 ways to lower your DTI ratio: increase your income or reduce your recurring debt.
To increase your income, you can:
- list all your debts and use the avalanche or snowball method to tackle them
- think about ways to make extra cash—picking up extra shifts, working a side job, etc
To reduce your recurring debt, you can:
- refinance your loans or consolidate debt
- make extra payments temporarily to pay off some loans early
Receive Personalized Financial Assistance
If you’re looking to improve your DTI ratio, the financial counselors at Navy Federal Credit Union may be able to help. Overcome your debt and craft a budget that works for you with personalized financial guidance from experts who care. Learn more about our services and get started today.