Used by lenders to assess your financial situation, a debt to income (DTI) ratio is used to work out the balance between your income and debt payments. If you have debt and you’re applying for a mortgage or loan, working out your DTI ratio will give you an indication of how much of a risk lenders may consider you.
In this guide, we’ll go through exactly what a DTI ratio is, how to calculate it and ways you can improve it.
What is debt to income ratio?
Essentially, your debt to income (DTI) ratio is how much of your gross income is used towards debt payments each month. Your gross income is the amount you receive per month before taxes or other deduction. This can include your monthly salary, allowances, benefits or any other financial earnings.
Calculating your DTI ratio can be a good way to assess your overall financial health by seeing what percentage of your income you have left after debt payments. There are various types of debt you may want to include as part of your DTI ratio calculation, such as:
- Mortgage or rent payments
- Credit card bills
- Overdraft
- Student loans
- Personal loans
- Car finance payments
- Council tax arrears
- Child support payments
- Debt repayments
Why is DTI important?
A DTI ratio gives an overview of your balance between income and debt. When assessing applications for loans or mortgages, lenders will often take your DTI ratio into account to determine your borrowing risk. This is because the more money you have left over after paying off debt, the more likely you are to be able to keep up with mortgage or loan payments.
Therefore, if you are thinking of getting a mortgage, it’s a good idea to work out what your DTI ratio is first. That way, you can judge how likely you are to be approved by a mortgage broker and what you may need to do to achieve a good DTI ratio.
What is a good debt to income ratio?
Generally speaking, the lower your DTI ratio is, the better. A low DTI ratio indicates that you have less debt to pay off with your income and more money available to cover any larger payments. Different lenders will have different maximum DTI ratios they’re willing to accept but as a rule of thumb, anything 39% or lower is considered good.
To give you a clearer idea of the impact of your DTI ratio on your mortgage eligibility, we’ve listed the risk factor of each percentage below:
- 0-19% – very low risk and very good chance of acceptance
- 20-29% – the majority of lenders will consider your application favourably
- 30-39% – a bit more of a risk but many lenders will still regard this as a good DTI ratio
- 40-49% – lenders will be more cautious and may want a good credit history and/or a larger deposit
- 50-74% – high risk borrower so fewer lenders will accept and if they do, a large deposit will likely be required
- 75-99% – very high risk meaning only a select few specialist lenders are likely to accept and this will often come with thorough checks of credit history and a very large deposit
- 100% or higher – almost all lenders won’t accept an application as the risk would be too high
Debt to income ratio calculator
Calculating your DTI ratio is simple. To get started, you’ll need to add up your monthly debt costs which can include any of the payments mentioned earlier. Once you have that figure, note it down so you don’t forget it.
After that, work out your gross monthly income. You can find this on your payslip or if you’re self-employed, add up the amount you’re paid before setting aside money for tax. Remember to also include any benefits or allowances you’re paid if applicable.
Once you have those two numbers, divide your monthly debt by your monthly gross income. You can then multiply the figure you get by 100 to get your DTI ratio percentage.
How to improve your DTI ratio
If you’re looking to apply for a loan or mortgage but your DTI ratio is fairly high, there are a number of things you can do to lower it. These include:
- Paying more than the minimum payment – if you are able to, paying more off towards your debt each month means your debt will reduce quicker, lowering your DTI ratio over time.
- Stopping using credit cards – debt can tend to amount quickly, especially if you consistently use credit cards with fees.
- Negotiating with creditors – if you reach out to your creditors, they may be willing to offer a lower interest rate or help with a payment plan so you can pay off your debt easier.
- Reviewing your credit report – this can help you ensure there’s no errors or inaccuracies that mean your DTI ratio is higher than it should be.
- Consolidating your debt – some debt solutions will place restrictions on further credit, however, you can consolidate all your remaining debts into a manageable monthly payments using a debt solution such as a DMP as this could lower your monthly debt payment.
- Increasing your income – you could take on a part-time job or side hustle to accumulate more income or negotiate a raise at your current job.
Concerned about your debt? Visit MoneyHelper for free advice and debt information. Alternatively, get in touch with us and we’ll be happy to help you out.
