What Is Debt-to-Income Ratio?

Your debt-to-income (DTI) ratio is all about showing how much of your monthly income goes toward paying off your debt. When you apply for a mortgage, auto loan, or any other loan, lenders look at this ratio to see how much debt you already have and how much more you can comfortably afford.

Synonyms

• Debt-to-Earnings Ratio
• Income-to-Debt Ratio
• Debt Obligation Ratio

Why Is Debt-to-Income Ratio Important?

The (DTI) ratio shows how much of your monthly income goes toward paying off debt. Lenders use this to figure out how risky it is to lend you money. A low DTI means you're managing your debt well, while a high DTI suggests you're juggling too much debt for your income.

If your DTI is low, you're seen as better at handling monthly payments, which makes lenders more likely to approve you for loans. Banks prefer to work with borrowers who keep their debt in check.

How Does Debt-To-Income Ratio Works

A debt-to-income ratio helps lenders figure out if you can handle more loans. Let’s say you earn N35,000 per month, and your car loan payment is N25,000. To find your current debt-to-income ratio, you’d divide your monthly debt (N25,000) by your gross income (N35,000), giving you a 71% DTI ratio.

Now, if your lender wants your DTI ratio below 39%, you’ll need to adjust your debt or increase your income to meet their requirements.

Types Of Debt-To-Income Ratios

• Front-End Ratio

When you apply for a mortgage or home equity loan, lenders look at your front-end DTI, which is just a way of saying they’re checking how much of your income goes towards housing costs. This includes things like your mortgage or rent, homeowners insurance, and property taxes.

They don’t count other debts, like credit card payments. If you're applying for a mortgage, they'll also factor in what your new housing costs would be if you're approved for the loan.

• Back-End Ratio

This ratio includes all of your housing costs (like in your front-end DTI) plus any other debts. It gives a fuller picture of your financial situation by including all your regular credit or loan payments.

How to Calculate Debt-To-Income Ratio

Your DTI shows how much of your monthly income goes toward paying off debt. It’s the percentage of your gross monthly income (before taxes) that’s used for rent, mortgage, credit cards, and other debts. Here's how to calculate your debt-to-income ratio.

Step 1:

Add up your monthly bills which might include:

• Monthly rent or mortgage alimony.
• Child support payments or house payments.
• Student loans, auto loans, and other monthly loan payments.
• Credit card minimum payments.
• Other debts.

Note: Expenses things like groceries, utilities, gas, and taxes usually aren't part of this.

Step 2:

Take the total amount and divide it by your income before taxes

Step 3:

The result is your DTI, is shown as a percentage. The lower the DTI, the less risky you look to lenders.

Formula: 

Monthly debt obligation (including mortgage payments) divided by Gross monthly income = Debt-to-income ratio %.

How To Improve Your Debt-To-Income Ratio

If a high DTI ratio is holding you back from getting approved, here’s what you can do to improve your numbers:

• Clear Pending Debt: This simple move can lower your debt-to-income ratio by reducing the size or number of your monthly payments.
• Increase Your Income: Getting a raise or taking on extra work improves your income and helps lower your DTI ratio.
• Delay Borrowing: If you know you’ll be applying for a major loan, like a mortgage, try to avoid taking on any other debt. Once you've secured the big loan, you can think about taking on additional loans if needed.

What Factors Affect Your Debt-to-Income (DTI) Ratio?

There are several factors that make up your debt-to-income ratio. Lenders look at all your monthly debt payments to figure out your DTI ratio. Which includes things like credit card minimums, student loans, car payments, alimony, child support, and your estimated housing costs, like your mortgage, property taxes, and homeowner's insurance.

That’s why your lender will check your bank statements and credit report during the loan approval process to get these details. But don't worry, monthly bills like utilities, insurance premiums, and other daily expenses usually aren’t included in the debt-to-income calculation.