Debt to Income Ratio

In personal finance, debt to income (DTI) ratio is the proportion of a person's income that goes into servicing debt. It is normally expressed as a percentage and calculated as monthly debt payments dividend by monthly gross income multiplied by 100.

A lower debt to income ratio is better because when debt-related outflows are low relative to income, lenders are more willing to offer additional financing.

Formula

Debt to income ratio can be calculated using the following formula:

 Debt to Income Ratio = Monthly Debt Payments × 100 Monthly Gross Income

Monthly debt payments are the debt payments that recur every month on all of the loans. These include payment on mortgages (both the principal and interest portion) or rent, auto loans, minimum payment on credit card, etc.

Monthly gross income is the income before tax for the month.

Example

In July 20X3, Alex Noriega earned $8,000 in monthly gross income. During the month he paid$900 on account of his mortgage ($300 interest and$600 principal repayment), minimum monthly payment on credit card of $200, property tax of$80, auto loan installment of $300. Further, he contributed$200 to a charity and paid advance of $500 to a furniture vendor for production of customized furniture. Find his debt to income ratio. Solution Monthly recurring payments in this scenario sum up to$1,480 [= $900 +$200 + $80 +$300]. Contribution to charity and advance for furniture are non-recurring payments that are not related to loans, so they excluded.

 Debt to Income Ratio = $1,480 × 100 = 18.5%$8,000

Alex has relatively low debt to income ratio which is a good thing because it enables him to raise additional financing easily if needed.

Written by Obaidullah Jan