A debt-to-income ratio is a personal finance measure that compares the amount of debt you have to your gross 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. It is calculated by dividing your total recurring monthly debt by your gross monthly income.
To calculate your debt-to-income ratio, start by adding up all of your recurring monthly debts, including your mortgage, which is likely one of your biggest debts. If you are purchasing a new home or looking to buy new real estate, an easy way to budget for that new debt expense is to calculate your total monthly mortgage costs using a mortgage calculator.
Beyond your mortgage, other likely recurring debts to include are:
- Auto loans
- Student loans
- Minimum credit card payments
- Child support and alimony
- Any other monthly debt obligations
Be sure to add up any of the applicable above-mentioned debts. Next, determine your gross (pre-tax) monthly income, being sure to include:
- Tips and bonuses
- Social Security
- Child support and alimony
- Any other additional income
Finally, divide your total recurring monthly debt by your gross monthly income. The quotient will be a decimal; multiply by 100 to express your debt-to-income ratio as a percentage.
Here's an example. Mary has the following recurring monthly debts:
- $1,000 mortgage
- $500 auto loan
- $200 student loan
- $200 credit card
- $400 other monthly debt obligations
Mary's total recurring monthly debt equals $2,300.
Mary has the following gross monthly income:
- $4,000 salary from primary job
- $2,000 from second job
Mary's gross monthly income equals $6,000
Mary's debt-to-income ratio is calculated by dividing her total recurring monthly debt ($2,300) by her gross monthly income ($6,000):
Debt-to-income ratio = $2,300 / $6,000 = 0.38
Multiply by 100 to express as a percentage:
0.38 X 100 = 38%
Mary's debt-to-income ratio = 38%
Less debt and/or a higher income would lower (and improve) Mary's debt-to-income ratio. For example, once Mary pays off her student and auto loans, her debt-to-income ratio (assuming all other factors remain the same) would be:
Total recurring monthly debt = $1,600
Gross monthly income = $6,000
Debt-to-income ratio = $1,600 / $6,000 = 0.27 or 27%.
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