How to Calculate Debt-to-Income Ratio

Your debt-to-income ratio (DTI) is an important financial metric that can affect your ability to qualify for a mortgage or other types of loans. 

In this article, we will explain the debt-to-income ratio, including what it is, why it’s important, and how to calculate the debt-to-income ratio so you can know where you stand before applying for a loan.

Contact Arkansas Federal Credit Union today to explore our different lending options and find what may work best for you.

What Does Debt-to-Income Ratio Mean? 

Your debt-to-income ratio, or DTI for short, is a financial metric lenders use to gauge your ability to manage payments and repay the money you are looking to borrow. In simple terms, it is the percentage of your total monthly income that you use to pay off debt. 

There are two types of DTI: 

1. Front-end DTI, which considers only housing-related costs in comparison to your income
2. Back-end DTI, which includes all of your monthly debt payments 

Most lenders will focus on your backend DTI when reviewing loan applications, since it provides a more holistic view of your finances and ability to repay the loan. 

Why is Debt-to-Income Ratio Important? 

Your debt-to-income ratio is important because it is one of the metrics lenders use to determine whether you’re approved for a loan, how much you qualify for, and the terms you are offered. 

While many people associate DTI with mortgages, it impacts much more than that. Even if you aren’t looking to buy a home, your DTI can impact other financing options such as auto loans, personal loans, motorcycle loans, and recreational loans. 

A strong DTI can help you qualify for larger loans and better terms, giving you more opportunities and potentially saving you money on interest. If your DTI isn’t as strong, your loan options may be limited or have higher borrowing costs. 

How to Calculate Debt-to-Income Ratio

Your debt-to-income ratio is the percentage of your gross monthly income compared to your monthly debts. In this section, we will walk you through how to find your debt-to-income ratio. 

Keep in mind that if you are applying with another borrower, you will need to include their income and debts in your calculation.

Step 1: Calculate your total monthly debt payments

This will vary slightly depending on whether you are calculating your front-end or back-end DTI. 

• Front-end DTI: Add up all housing-related costs, including your mortgage or rent, HOA fees, homeowners’ insurance, and property taxes.
• Back-end DTI: Include everything from the front-end calculation (housing costs) plus any additional debt payments, including auto loans, student loans, credit cards, child support, or any other installment loans. 

You do not need to include expenses like utilities, health insurance premiums, retirement contributions, or groceries in your calculation.

Step 2: Calculate your total gross monthly income

This is all the money you earn before taxes each month. Include your salary, income from any side gigs, investment income, and any child support or alimony you receive. 

Step 3: Divide and convert to a percentage

Once you have your total monthly debts and gross monthly income, divide your total debt by your total income. Then, multiply the result by 100 to get your DTI percentage. 

For example, if your monthly debt payments are $2,000 and your gross monthly income is $8,000, your DTI would be 25%. 

What is a Good Debt-to-Income Ratio?

Every lender has their own requirements, but generally speaking, a DTI ratio of 35% or below is considered good. You can still be approved for a loan with a higher DTI, and many lenders consider ratios up to 41% acceptable. 

If your DTI is higher and you are concerned about approval, you may still be able to qualify for certain loan programs, such as an FHA Loan. 

Because lenders have different guidelines, it is a good practice to keep your DTI as low as possible to give yourself the most options. 

Explore Your Lending Options with Arkansas Federal

Your DTI is an important factor when applying for a loan, since a strong debt-to-income ratio can give you more borrowing opportunities and better loan terms. Even if your DTI isn’t as competitive, you still have financing options available to you. 

If you’re considering applying for a mortgage or other type of loan, contact Arkansas Federal today. Our team can talk to you about your specific situation and share lending options that can work for you.