A:

A debt-to-income ratio is a personal finance measure that compares the amount of debt you have to your overall income. Lenders use the debt-to-income ratio as a way to measure your ability to manage the payments you make each month and repay the money you have borrowed. The ratio is calculated by dividing your total recurring monthly debt by your gross monthly income. For example, if your total recurring monthly debt is $2,000 and your gross monthly income is $6,000, your debt-to-income ratio would be 33% ($2,000 / $6,000 = 0.33, or 33%).

There are two ways to lower your debt-to-income ratio:

  • Reduce your monthly recurring debt
  • Increase your gross monthly income (or a combination of the two)

In the above example, the debt-to-income ratio was 33%, based on total recurring monthly debt of $2,000 and a gross monthly income of $6,000. If the total recurring monthly debt were reduced to $1,500, the debt-to-income ratio would correspondingly decrease to 25% ($1,500 / $6,000 = 0.25, or 25%). Similarly, if debt stays the same as in the first example but we increase the income to $8,000, again the debt-to-income ratio drops ($2,000 / $8,000 = 0.25, or 25%).

Of course, reducing debt is easier said than done. It can be helpful to make a conscious effort to avoid going further into debt by considering needs versus wants when spending. Needs are things you have to have in order to survive: food, shelter, clothing, health care and transportation. Wants, on the other hand, are things you would like to have, but that you don’t need to survive. Once your needs have been met each month, you might have discretionary income available to spend on wants. You don’t have to spend it all, and it makes financial sense to stop spending so much money on things you don’t need. It is also helpful to create a budget that includes paying down the debt you already have.

To increase your income, you might be able to:

  • Find a second job or work as a freelancer in your spare time
  • Work more hours or overtime at your primary job
  • Ask for a pay increase
  • Take on more responsibility at work
  • Complete coursework and/or licensing that will increase your skills, marketability and salary
RELATED FAQS
  1. What are the differences between balance-to-limit ratio and debt-to-income ratio?

    Learn how to differentiate between your balance-to-limit ratio and your debt-to-income ratio, how they are calculated, and ... Read Answer >>
  2. If a company has a high debt to capital ratio, what else should I look at before ...

    Learn about some of the financial leverage and profitability ratios that investors can analyze to supplement examining the ... Read Answer >>
  3. How do I use the debt ratio to decide when to invest in a company?

    Understand the calculation and interpretation of the debt ratio and how this metric is used by investors to analyze a company's ... Read Answer >>
  4. What are the most common leverage ratios for evaluating a company?

    Learn more about some of the most common leverage ratios used by traders to determine whether a company is using debt in ... Read Answer >>
  5. What is the debt ratio for an FHA loan?

    Borrowing through the Federal Housing Administration requires individuals to provide proof of income as well as information ... Read Answer >>
  6. Does a high debt to capital ratio make a company a bad investment?

    Understand the debt to capital ratio and why a high debt to capital ratio doesn't necessarily mean that a stock is a bad ... Read Answer >>
Related Articles
  1. Credit & Loans

    5 Ways to Up Your Chance of Getting a Mortgage

    Tips and ways to improve your chances of getting a mortgage.
  2. Investing

    To Invest Or To Reduce Debt, That's The Question

    Find out how you can make use of that excess cash and improve your financial situation.
  3. Credit & Loans

    Digging Out Of Personal Debt

    Find out why good intentions can put consumers in an even bigger hole than before.
  4. Credit & Loans

    Mortgage Basics: Loan Eligibility

    By Lisa Smith"How much house can I afford?" It's a critical question that every homebuyer faces, and one that many people answer by going to a lender and taking out the largest mortgage that ...
  5. Credit & Loans

    8 Must-Have Numbers For Evaluating A Real Estate Investment

    These calculations can help you figure out if a particular property will be a valuable investment.
  6. Budgeting

    How Much Debt Can You Handle?

    Follow these five steps to manage debt without cutting up your credit cards.
  7. Home & Auto

    Bank Vs. Budget: How Much House Can You Afford?

    Learn whether you can afford the mortgage that the bank will lend you.
  8. Budgeting

    Debt Consolidation Made Easy

    These five steps can help get you out of debt faster and easier than you'd ever imagined.
  9. Budgeting

    Mortgages: How Much Can You Afford?

    Answering this means number-crunching as well as factoring in other considerations and expenses.
  10. Retirement

    5 Signs You're Spending Too Much In Retirement

    You're finally retired – free to have all the adventures you've dreamed of. Just be sure you have a budget and watch for these 5 signs you're overspending.
RELATED TERMS
  1. Debt-To-Income Ratio - DTI

    A personal finance measure that compares an individual's debt ...
  2. No-Ratio Mortgage

    A mortgage program in which a borrower's income isn't used or ...
  3. Recurring Debt

    Any payment used to service a debt obligation that occurs on ...
  4. Back-End Ratio

    A ratio that indicates what portion of a person's monthly income ...
  5. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  6. Front-End Debt-to-Income Ratio - DTI

    A variation of the debt-to-income ratio (DTI) that calculates ...
Trading Center