What you need to know about your debt-to-income ratio

Understand the number lenders use to predict your ability to repay a loan — and how to swing it in your favour.

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Your credit score isn’t the only thing you need to worry about when applying for a new credit card or loan. Having a good debt-to-income ratio (DTI) is also key to qualifying for financing — and understanding it can set you on the path to getting a better interest rate or a more favourable loan term.

Read on to find out what this mighty number is, how to calculate your DTI and what you can do to lower it.

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What is a debt-to-income ratio?

A debt-to-income ratio (DTI) is the amount of debt repayments you make each month divided by your income. Lenders use your DTI as one way to make sure you’re in a position to afford your loan repayments.

monthly debt ÷ monthly income = debt-to-income ratio

Typically, underwriters figure out your DTI themselves — however knowing your ratio before you apply can help you tell if it’s a good time to apply for financing. If your score is too high, you might want to consider paying off some debt first in order to avoid high rates or getting rejected.

Calculating your debt-to-income ratio

Calculating your DTI doesn’t require complicated math once you understand what the terms debt and income cover.

Here’s how to calculate your debt-to-income ratio:

  1. Add up all of your monthly payments on existing debts.
  2. Add up your monthly income before taxes and deductions (for many people, this is just a salary).
  3. Divide your total monthly debt repayments by your total monthly income.
  4. Turn that decimal into a percentage.

Let’s take a look at two examples.

1. Anita’s a recent university graduate who wants to apply for a credit card to improve her credit score. She makes $48,000 a year before taxes as a full-time project manager at a local nonprofit. Her only debt is student loan repayments. Figuring out her DTI is pretty simple:

Total debt$400 a month in student loan repayments
Total income$4,000 before taxes
Debt-to-income ratio400/4,000 = 0.1 or 10%

2. Frank wants to apply for a personal loan to help cover the cost of his son’s wedding, but his situation is a bit more complicated than Anita’s. He’s 66 years old, makes $75,000 a year and receives monthly CPP and OAS benefits. He also has a mortgage, a car loan and two credit cards that he pays off each month. Here’s how Frank calculates his DTI:

Total debt$599 mortgage repayment +
$479 car loan repayment +
$20 minimum credit card payment +
$75 minimum credit card payment =
$1,173
Total income$6,250 a month salary +
$500 a month CPP and OAS =
$6,750
Debt-to-income ratio$1,173/$6,750 = 0.17377777 or about 17.38%

What’s considered a good DTI?

The lower the DTI, the better. More specifically, a DTI of 36% or below is generally considered good, while a DTI of 37-42% is considered manageable. A DTI of 43% or higher will likely mean you won’t qualify for a loan, as anything 43% or higher is considered cause for concern. A DTI of 50% or higher is considered dangerous.

Why 43%? Lenders came up with this number as a result of mortgage-risk studies that analyzed the type of borrowers who are most likely to have trouble making repayments — and ultimately default on their loans.

Your DTI is a factor lenders consider when determining the rates and terms of your loan. In general, you’re more likely to get a better rate with a lower DTI.

Defining debt and income

To calculate your DTI, you first need to know what counts as debt and what counts as income.

  • What counts as debt?

    Debt includes your regular monthly repayments on personal loans, student loans, car loans, mortgages or any other type of loan. Your monthly minimum credit card payments also count as debt, as do unpaid bills sent to collection agencies.

  • What doesn’t count as debt?

    Things like rent, utility bills, cable bills (or, let’s be real, Netflix subscription fees) aren’t included in your DTI. Car insurance, health insurance and other types of insurance premiums also don’t count as debt.

    You might think that monthly bills besides credit card and loan payments should count — but here’s why they don’t: With these bills, you’re paying for a service, typically one that’s consistent.

  • What counts as income?

    The income DTI refers to is your gross monthly income — that is, your income before taxes or deductions are subtracted. Income includes your salary, but it’s not limited to just what you bring in each month.

    Tips or bonuses, CPP and OAS benefits, alimony and child support all count as income too. Think of income as any kind of money that’s coming in that you don’t have to repay.

  • What doesn’t count as income?

    In one word: Loans. Borrowed money doesn’t count as income because it’s money you have to pay back — in other words, it’s actually debt.

    You also can’t include income that you don’t have reasonable access to when calculating your DTI. As an example, if you’re a student and still count as a dependent when your parents file for taxes, even if you get most of your money from your parents, you can’t count their income as yours when applying for a credit card or student loan.

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Your lender didn’t ask about your debt or income? It could be a scam.

If your lender doesn’t want to know how much you owe or earn, it’s just one sign that it might be untrustworthy and ultimately a scam.

If you come across a lender that markets itself in this way, make sure it’s legitimate before signing on. Read online reviews, check out its accreditations and confirm that it has no complaints on the Better Business Bureau website.

My DTI is too high. How do I lower it?

With rising debt amounts across the country, you’re probably not alone if your debt-to-income ratio is above or close to the 43% mark. Here are some ways you can lower your DTI:

  • Pay off your loans ASAP. Getting rid of even one large monthly debt expense can make a huge difference in lowering your DTI. Understand your loan’s early repayment policy before making any extra repayments. Some come with penalties for paying early, while others require that you follow a specific procedure for successful payoffs.
  • Creatively boost your income. You don’t necessarily need to take on a second job to make extra money. Bringing in more cash could be as simple as having a garage sale, selling old records or writing online reviews.
  • Pay off (or at least pay down) your credit card balances. Pay what you can beyond your due monthly minimum. The larger your balance, the higher your monthly payment — which ultimately increases your DTI.
  • Consolidate your debt. Balance transfer cards or debt consolidation loans at a lower rate can make it easier to retire your debt quickly, because you won’t have to pay as much on interest.
  • Rent instead of buying. Renting isn’t always a smarter financial move in general, but when it comes to keeping your DTI low, it could be. That’s because rent doesn’t count as a debt, whereas mortgage payments do.

My personal loan application was rejected because of my DTI. What do I do?

If you don’t need the loan right away, consider holding off on reapplying until you’ve taken steps to improve your DTI. Showing that you can repay your loan is one of the most important factors to a reputable lender.

If it’s an emergency, consider applying for a short-term loan, which often comes with more lenient eligibility requirements. Keep in mind there’s no guarantee you’ll be approved for a short-term loan either. Even if you are approved, you could end up with astronomical interest rates that can send you into a debt spiral if you’re unable to make your repayments on time.

Bottom line

Your debt-to-income ratio is an important factor that is considered when you apply for a loan — and is right up there with how important a factor your credit score is. While many lenders calculate your DTI for you, knowing yours can help you figure out the type of loan you can qualify for.

If your DTI is over 43%, consider taking steps to lower it before applying for new credit.

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