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What is Your DTI Ratio?
DTI — these three small letters hold enormous insight into your financial situation.
Standing for Debt-to-Income, it’s a ratio that some financial institutions check before they approve you to take out a loan or line of credit. They check it because your DTI ratio says a lot about your cash flow; it reveals just how much of your money goes towards debt payments each month.
Your DTI Defined and Explained
Your DTI ratio presents your debt payments as a percentage of your gross income. That’s the amount you earn before any taxes or deductions get taken off your paycheck.
In other words, your DTI ratio shows what percentage of your salary covers loans and credit obligations. These obligations may include the following expenses:
- Rent or mortgage payments
- Credit card bills
- Personal loans
- Auto loans or lease payments
- Home equity loans
- Lines of credit
- Student loans
Why is Your Debt-to-Income Ratio Important?
Borrowing money is normal, so you can expect to take out a loan or line of credit at multiple points in your life. You might even borrow a personal loan if you need money now in an emergency without savings.
Relying on credit at strategic points in your life isn’t cause for alarm. However, you may encounter trouble when you owe a lot of money.
Your DTI ratio helps put your debt into perspective. It might be an eye-opener to see your debt expressed as a percentage, which can help you fast-track your debt repayment plan.
It’s also an important ratio in the financial world, from a lender’s point of view. Some financial institutions review your DTI ratio before they lend you money. They want to see if you have the cash flow to handle their loan payments, should they approve you. A higher DTI generally makes it harder to borrow, but not impossible.
What Are the DTI Ranges?
DTI ratios are unusual in that these percentages don’t top out at 100%. Depending on your finances, you can have a DTI that surpasses 100. In fact, the average American has a DTI of 145%, according to the Federal Reserve.
It might be obvious a ratio this high needs to be fixed. But what about borrowers who fall somewhere else? There’s a range that can help you understand where you stand:
0%–35% | Good
The lower your ratio, the better. However, most guides agree anything below 35% is manageable. At this ratio, there’s a good chance you still have money left over to spend and save as you wish.
36%–49% | Needs Improvement
As your percentage climbs, your cash flow drops. You’ll have less money to pay non-debt bills, save, or splurge. At this point, you should focus on bringing your ratio below 36%.
50% and Above | Red Flag
Once you spend half of your monthly income or more on debt, you’ll start to feel the pinch. Since so much of your paycheck goes towards loans and lines of credit, you’ll have less to use on the rest of your budget.
In many cases, people put a pause on savings or splurge spending to make sure they cover their essentials. This budgeting scenario makes you more vulnerable to unexpected expenses, as you won’t have savings to dip into for emergencies. You might have to borrow more often as a result.
What’s Your DTI?
Crunch the numbers to find out your ratio. This financial litmus test can help you put your debt into perspective.
