Your credit score matters (especially if it’s low), but it’s not the only number that you should care about when it comes to your money. If you’re paying off debt, for example, you want to be aware of something called your debt-to-income ratio. It doesn’t just affect your ability to get loans; it’s also just a good overall measure of your financial health.
What is your debt-to-income (DTI) ratio?
Generally speaking, your debt to income ratio is pretty much what it sounds like: the ratio of debt you have divided by your gross monthly income. Whereas your credit report and score doesn’t include any details about your income relative to your debt load, that’s exactly what your DTI ratio is all about.
“DTI is a more holistic way to see if you’re living within your means because it provides a true view of your monthly debt obligations relative to your monthly income,” says Erin Lowry, author of Broke Millennial. “A credit score is certainly a piece of your financial profile, but not the full picture. For example, you can be heavily burdened with debt and still have a strong credit score.”
If your DTI ratio is high, lenders might not loan you money or credit, or they may give you worse interest rates, even if your credit score is in shape. This doesn’t really matter if you’re not shopping for a loan or credit card, but you still want to avoid a high DTI ratio if only because a higher ratio means you’ll have a harder time paying back your debt.
How to calculate your DTI ratio
It’s pretty easy to calculate your own DTI ratio, but there are online tools that will do it for you automatically and keep track of it, too. Intuit’s newly released Turbo app, for example, monitors your credit score but also tracks your DTI ratio and gives you personalized advice. If you’re already a TurboTax or Mint.com user, you can use your login credentials to try Turbo yourself.
If you want to do the math yourself, it’s simple:
"DTI ratio is a simple formula. Divide your monthly debt obligations divided by your gross monthly income, and multiply that number times 100,” says Lowry, who partnered with Turbo.
For example: Let’s say you pay $200 a month in student loans, $850 on rent and $120 for your auto loan. Your monthly gross income is $3,500.
($200 + $850 + $120) ÷ ($3,500) = 0.3342
Then, x 100
= 33.42 percent
When you’re applying for a mortgage, be aware of something called your household ratio in addition to your DTI ratio (which can also be referred to as your back-end ratio.) Your household ratio is the amount of your home-related expenses (including property tax, prospective mortgage, insurance, etc.) divided by your monthly income.
“While mortgage lenders typically look at both types of DTI, the back-end ratio often holds more sway because it takes into account your entire debt load,” Nerdwallet says.
The “ideal” DTI ratio
Ideally, you want to keep your DTI at 36 percent or less, Lowry says. At least, that’s a ballpark figure lenders look for when deciding your creditworthiness. According to Nerdwallet, mortgage lenders also prefer a household ratio that’s even lower.
“Lenders tend to focus on the back-end ratio for conventional mortgages, loans that are offered by banks or online mortgage lenders rather than a government program,” they report. “If your front-end DTI is below 28 percent, that’s great. If your back-end DTI is below 36 percent, that’s even better.”
Of course, you should aim for a DTI ratio of 0 percent if your goal is to be debt free. Either way, it’s another number to keep tabs on, beyond your credit score.