Debt-to-income Calculator
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What is a debt-to-income ratio?
The debt-to-income (DTI) ratio is a financial metric calculated by dividing your total monthly debt payments by your gross monthly income. This ratio, expressed as a percentage, helps lenders evaluate your ability to manage debt and determine whether you can afford to take on additional loans.
Lenders typically consider borrowers with higher DTI ratios to be riskier, as they may struggle to repay loans during financial hardships.
To calculate your DTI ratio, sum up all your monthly debt obligations—such as rent or mortgage payments, student loans, personal loans, auto loans, credit card payments, child support, alimony, and similar expenses. Then, divide that total by your gross monthly income. For example, if your monthly debt totals $2,500 and your gross monthly income is $7,000, your DTI ratio would be approximately 36% (2,500 ÷ 7,000 = 0.357).
What factors make up a DTI ratio?
Here’s a simple three-step process to calculate your debt-to-income (DTI) ratio:
- Add up all your monthly debt payments. These include your mortgage or rent, minimum credit card payments, auto loans, student loans, personal loans, alimony, child support, or any other debts listed on your credit report.
- Divide your total monthly debts by your gross monthly income. Gross income is your income before taxes and other deductions.
- Convert the result into a percentage. This percentage is your DTI ratio.
It’s important to note that other monthly expenses, such as utilities, groceries, insurance premiums, healthcare costs, and daycare, are not included in this calculation. Lenders don’t factor these into their decision when determining how much money to lend you. However, qualifying for a loan doesn’t necessarily mean you can comfortably afford it. For example, while you may qualify for a $300,000 mortgage, be sure to account for all your monthly expenses to ensure the payments fit within your overall budget.
What is an ideal debt-to-income ratio?
Lenders generally recommend that your front-end DTI ratio—covering housing expenses—should not exceed 28%, while your back-end DTI ratio, which includes all monthly debts, should stay at or below 36%. However, in practice, these limits can vary based on factors such as your credit score, savings, assets, and down payment.
For conventional loans backed by Fannie Mae and Freddie Mac, lenders may approve borrowers with DTI ratios as high as 50%. This means up to half of your monthly income could be allocated to housing costs and other recurring debt payments.
Does my debt-to-income ratio impact my credit?
Credit bureaus don’t consider your income when calculating your credit score, so your DTI ratio has little direct impact on it. However, a high DTI ratio often correlates with a high credit utilization ratio, which accounts for 30% of your credit score.
Your credit utilization ratio is the amount of credit you’re using compared to your total credit limit. For example, if you have a credit card with a $2,000 limit and a $1,000 balance, your credit utilization is 50%. Ideally, you should aim to keep this ratio below 30%, especially when applying for a mortgage.
Reducing your credit utilization not only improves your credit score but also helps lower your DTI ratio by paying down debt. This makes you a more attractive borrower to lenders.
How to lower your debt-to-income ratio
To better manage your DTI ratio, focus on paying down debt with these four strategies:
Create a budget and track your spending.
Start by creating a detailed budget that includes all your expenses, no matter how small. Identify unnecessary purchases you can cut back on, and redirect those funds toward paying down your debt. By having a clear picture of your spending habits, you can prioritize debt repayment more effectively.Plan your debt repayment strategy.
Choose a repayment method that works best for you, such as the snowball or avalanche method:- The snowball method focuses on paying off the smallest debt balance first while making minimum payments on other debts. Once the smallest debt is paid off, move to the next smallest, building momentum as you go.
- The avalanche method (or ladder method) targets debts with the highest interest rates first. After paying off the highest-interest debt, move on to the next highest, saving money on interest over time.
Whichever method you choose, consistency is key. Tools like Agape's debt payoff calculator can help you stay on track.
Make your debt more affordable.
Look for ways to lower interest rates and simplify payments:- Contact your credit card issuer to request a lower interest rate, especially if your account is in good standing and you’ve been making on-time payments.
- Consider consolidating high-interest debt by transferring balances to a card with a lower interest rate or taking out a personal loan with better terms. This can help reduce your interest costs and make managing your debt more straightforward with one monthly payment.
Avoid taking on new debt.
Steer clear of large purchases on your credit cards or taking out new loans, especially before or during a home purchase. Adding new debt will increase your DTI ratio and could negatively impact your credit score. Additionally, too many credit inquiries in a short time can lower your score. Stay focused on paying down existing debt and resist adding to the problem.
By following these steps, you can reduce your DTI ratio, improve your financial health, and make yourself a stronger candidate for loans.
