What Factors are Used to Calculate my Debt to Income Ratio?

You may be new to the world of financing, or you may have just never been too aware of what it means, but knowing your DTI, at any given moment, is pretty important for maintaining a balanced financial life.

Your DTI, or Debt to Income Ratio, will play a huge factor whenever you try to apply for any type of loan. By knowing your DTI in advance, you will have a rough idea of the terms and conditions you can expect to receive when you are approved for a loan. While your DTI is not the only factor that lenders will analyze when considering your loan application, it certainly is one of the most important.

With that in mind, let’s take a closer look at what DTI is, how it’s calculated, and how it can affect your ability to receive a loan.

What is Your DTI?debt

Your DTI is, in simple terms, a percentage based on the money you make, versus how much you’re obligated to spend. DTI can become very confusing for some people because it can be difficult to define what qualifies as debt for the purposes of calculating your DTI, and what doesn’t.

What may be helpful for you in making that distinction is to understand some of the factors that are used to calculate your DTI:

Your Income

As it says in the name, your income is the first hard number that will be referenced when calculating your DTI. The generally accepted rule is that, the more money you make, the better your odds for having a better DTI, and by extension, the better your chances at getting more money through a loan. This isn’t always the case, however, and we’ll discuss why later.

Your Front End Debt

Front end debt is any debt that is recurring debts you have towards your home. Example of front end debt include things like mortgage payments, and homeowner’s insurance payments.

Your Back End Debt

Back end debt refers to any recurring debts that you have aside from recurring debts

toward your home. Back end debts can include car payments, credit card minimum payments, and college loan payments.

How do I Calculate My DTI?

The formula to calculate your DTI is fairly straightforward and simple. You add your front end debt, plus your back end debt, then divide the sum by your monthly income. In other words, front end debt + back end debt / monthly income = DTI. I understand if this is confusing, and you can use our site’s DTI calculator to help you figure out your DTI.

What Kind of Debts Qualify for a DTI calculation?

As I’ve already mentioned, the debts that are calculated between your front end and back end debts qualify, but you might be thinking, what about grocery bills, utilities, and other similar bills you have to pay every month? These do not necessarily qualify.

DTI is used as a reference for lenders to see just how much you’re making versus how much you’re spending. You can’t possibly predict every single purchase you’ll have to make each and every month, and even on recurring purchases, the amounts can vary.

You may be spending $100 a week on groceries right now, but if you decide to get healthier with totally organic foods that cost more, your total spending might shoot up to $200 a week. In that same line of thought, you might be spending about $100 dollars on utilities in the summer, since you keep your air conditioner turned down fairly low, but you just can’t stand the cold, so you crank up your heater in the winter, and your bill shoots up to $300 a month.

It’s impossible to predict each and every expense you’ll have each month, so lenders stick with debts that are predictable, and will always be the same amount. As a general rule of thumb, if it shows up in your credit report, it will probably be used in your DTI.

Why is DTI Important?

In essence, your DTI serves as a fairly accurate indicator of how likely you’ll be able to handle additional debt. If you’re living well within your means, and have a low DTI, then to a lender, odds are you can manage making your loan repayments.

By contrast, if your DTI is on the higher end of the scale, then you could find yourself struggling to make your monthly loan payments, particularly if an emergency comes up.

What is a Good Range for a DTI?

This is a fairly subjective question, because different lenders have different stances on how much risk they’re willing to take, or how much money they’re willing to loan for different DTIs. The most common answer to this question, and a generally good goal to shoot for, is no more than 35%.

Most lenders perceive a DTI of 35% to be normal, meaning that you’ve got the same debts that everyone else has, but you manage them well with what you make. In other words, you live within your means. Does that mean that you’ll automatically get a loan, or that you’ll get a large sum offered to you? No, it certainly doesn’t. Remember I mentioned earlier that a good DTI doesn’t always lead to a good loan? Here’s why:

If you think about it, your DTI may be exceptional, say only 25%, but if you’re still only making $20,000 a year, and compensate by living in a shack that costs $300 a month in rent, you’re still only bringing home $16,400 a year. With numbers like that, it’s not feasible to expect that you’ll just instantly get a loan for $500,000, or some other extravagant amount. That’s why your base income is a factor in and of itself.

How Can I Improve My DTI?

There’s really only two ways you can improve your DTI: reduce your debt, or make more money. The latter you can do by getting a raise, getting a new job, or getting a side job. The former may be a little more challenging, if you’re living conservatively as it is. You might consider trading in your car for a cheaper one, or else giving up your apartment for a cheaper one, if you’re able.

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