How to Calculate Your Debt-to-Income (DTI) Ratio

Tyler Parker, Preferred Banking Office Manager, First Republic Bank
February 9, 2022

• The debt-to-income ratio (DTI) helps you understand how much money you’re bringing in versus how much is going out, which is a key metric in gauging your financial health.
• To calculate your DTI ratio, you need to know both your monthly income and your total monthly debt payments.
• A low DTI ratio is preferable since it indicates a higher likelihood of being able to pay off debts while maintaining a solid financial cushion each month.

Understanding how much money you’re bringing in compared to how much money is going out is a key metric for not only measuring your financial health but also navigating your financial future. The way to measure this metric is by calculating what is called your debt-to-income ratio (DTI). This ratio reflects how likely you are to be able to pay off debt obligations each month.

Your debt-to-income ratio can help you make large financial decisions, and it also helps lenders determine whether and how they want to work with you. You may already be familiar with the idea of DTI ratio and striving toward a good DTI ratio. To determine whether you’re there — or moving in the right direction — you will need to know how to calculate the DTI ratio on your own.

Depending on your financial institution, DTI can be calculated using gross monthly income or using income net of an assumed tax rate. For simplicity, the example below is using gross monthly income:

 Debt-to-Income Formula DTI% = (total monthly debt payments / gross monthly income) x 100

Step 1: Add up monthly debt payments

The first step to calculating the debt-to-income ratio is summing how much debt you pay down each month. This part of the calculation matters because it reflects how much money is flowing out of your account toward debt payments.

Several costs should be considered when calculating your monthly debt payments:

• Rent or mortgage payments
• Auto loan payments
• Minimum credit card payments
• Personal loan payments
• Student loan payments

Monthly variable bills, such as groceries, gas, utilities and more, aren’t usually included in this calculation. However, homeowners insurance, homeowner’s association (HOA) fees and property taxes are often included, as they are part of your mortgage payment.

An example calculation of monthly debt payments can help you understand this component of the DTI ratio formula. This example accounts for rent, an auto loan and a credit card balance to reach a total monthly debt payment of \$1,800:

Example: \$1,050 rent payment + \$350 auto loan payment + \$400 card payment = \$1,800 monthly debt payment

Front-end ratio vs. back-end ratio

The DTI ratio offers two variations — the front-end DTI and back-end DTI — with a few key differences between the two and how you calculate them. The front-end DTI calculation reflects housing expenses divided by gross monthly income. In contrast, the back-end DTI formula includes other types of debt, including credit card balances and auto loans.

Step 2: Divide by gross monthly income

Once you have your total monthly debt calculation, the next step is to take your total monthly debt payments and divide them by your gross monthly income. This part of the calculation is important since it determines how much money you have coming in each month.

Gross monthly income: The amount of money you earn each month (wages, interest, bonuses, capital gains, etc.) before taxes and deductions are taken out.

This is different from adjusted gross income, which reflects your gross monthly income, minus deductions and adjustments.

Below is an example to illustrate where the gross monthly income calculation fits into the DTI ratio formula. This example is based on a \$60,000 gross yearly income (to obtain the monthly amount, divide by 12 to reflect 12 months).

Example: \$1,800 total monthly debt payment / \$5,000 gross monthly income

Step 3: Multiply by 100 for percentage

Once this division is complete, you must multiply by 100 to obtain your DTI percentage.

Example: \$1,800 total monthly debt payment/\$5,000 gross monthly income x 100 = 36%

This percentage represents your DTI ratio.

• A lower DTI ratio means: You have a good balance between your debts and income. A low DTI means you are more likely to be able to pay off your monthly debts.
• A higher DTI ratio means: Monthly debt payments take up a high percentage of your gross monthly income. A high DTI ratio means you are less likely to pay off your monthly debts with a comfortable cushion.

Ultimately, this metric is a key indicator of your overall financial health. It’s important to note that your DTI ratio will never affect your credit score or credit report.

How lenders see your DTI ratio

Lenders see the DTI ratio of potential borrowers, and the percentage gives them a sense of borrowers' current debt and how easily they may be able to pay off their obligations. It’s important to note that how lenders interpret and apply your specific DTI ratio if you're applying for credit will vary based on the lender or financial institution. Ultimately, this number can help them determine your interest rate if you are approved.

 The Consumer Financial Protection Bureau (CFPB) emphasizes the importance of keeping a DTI below 43% since this is the highest ratio a borrower can have and still get a Qualified Mortgage.

Once you have your own DTI, you’ll be prepared with an essential perspective on your finances, which can help you make important financial decisions. For example, you may be ready to look at your financing or refinancing options. In other scenarios, you may want to pursue ways to improve your DTI ratio first.

No matter what your DTI ratio says about your finances, you don’t need to take your next steps alone. You can seek help from a First Republic financial expert to confidently determine what’s best for you.

The strategies mentioned in this article may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this document. This information is governed by our Terms and Conditions of Use