How To Calculate The Debt-To-Income Ratio (With Examples)

Updated 25 October 2022

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Creditors use various techniques to determine if a client is eligible for loans. One of these techniques is the debt-to-income (DTI) ratio, which assesses the level of risk associated with providing loans to a client. If you work in the finance industry, you can benefit from learning about the DTI ratio and the steps involved in its calculation. In this article, we discuss what the debt-to-income ratio is, learn why it is important, find out how to calculate it using a few examples and review some tips on how clients can reduce their debt:

What Is The Debt-To-Income Ratio?

Debt-to-income ratio is the ratio of a client's total monthly debt to their gross monthly income. It is a type of credit score metric that banks use to assess the creditworthiness of a client. Creditors often use the DTI ratio and other background checks before sanctioning client loans. A low DTI ratio implies that a client's gross income is much higher than their monthly debt, allowing them to repay their loans quickly.

A higher DTI ratio indicates a client spends most of their income on repaying their debts. Creditors often classify them as high-risk borrowers because of the possibility of late repayments or defaults. Depending on the creditors, these clients may be eligible for loans but at a very high-interest rate. The two essential factors in calculating the DTI ratio are:

Gross income: This is the total amount that an individual makes every month, excluding tax and other deductions. This includes wages from various sources, such as fixed salary, contractual work, rental income, business profit, freelancing and income from interest.
Debt: Debt is the amount of money that an individual requires paying to the creditor, including the interest incurred per annum. The various loans may include personal loans, car loans, education loans and credit card repayments.

How To Calculate The DTI Ratio

Follow these steps if you want to calculate a client's DTI ratio:

1. Calculate the gross monthly income

Collect client's sources of income. Some clients may get paid hourly based on their contractual agreement, while others may get fixed salaries. In the case of hourly rates, multiply the hourly rate by the number of hours they work per week. Multiply this number by 52 to calculate their gross annual income. Divide this number by 12 to get the gross monthly income. If clients earn a fixed income, divide their gross annual income by 12. Add all sources of income, such as salary and business income, to obtain the gross monthly income. Consider this example:

A client working as a senior consultant earns ₹1500 per hour and provides 25 hours of service to a company. Along with this, the client also earns ₹10,000 from rent every month. Multiplying 1500 by 25 gives ₹37,500. This is the client's weekly income. Multiplying ₹37,500 with 52 gives the gross annual income, which is ₹19,50,000. Dividing this by 12 gives the monthly income, which is ₹1,62,500. Adding this with the rental income gives the gross monthly income of ₹1,72,500.

2. Find the total monthly debt

Request the client to provide all debt-related information, such as equated monthly instalments (EMI) on house loans, car loans, education loans and other debt obligations. It is advisable for clients to consolidate all the information in a single place. The sum of all monthly debts equals the total monthly debt payment. Consider the example:

The client has a house loan of ₹25,000 per month and an education loan of ₹19,000. The client also owes ₹15,000 on credit card bills. Adding all the values gives ₹59,000. This is the total monthly debt payment.

3. Divide the two values

The formula used to calculate the DTI ratio is:

Debt-to-income ratio = (Total monthly debt payment / gross monthly income) x 100

After calculating the gross monthly income and the total monthly debt payment, find the DTI ratio by dividing the monthly debt payment by the gross monthly income. In the previous example, the gross monthly income is ₹1,72,500 and the total monthly debt payment is ₹59,000. Review the DTI ratio calculation:

DTI ratio = 59000/172500 = 0.342

4. Convert the ratio into a percentage

Once you have calculated the DTI ratio, you can convert it into a percentage by multiplying it by 100. Most creditors prefer lending to clients with a DTI ratio below 35%. If the debt is more than 35%, most creditors require additional eligibility requirements. Review the last step of the example:

DTI ratio (%) = 0.342 x 100 = 34.2%

The client's DTI ratio is 34.2%, slightly below the threshold of 35%. Creditors may approve the loan request based on this value.

Why Is It Important To Calculate The DTI Ratio?

Creditors can use the DTI ratio to assess a client's financial health and ability to manage finances. In the finance industry, the widely used DTI ratios are:

35% or less: Creditors prefer lending to clients that have a DTI ratio below 35%. This indicates that a client's debt is manageable and they have money left after clearing their monthly debts and paying their bills.
36% to 49%: If a client's DTI ratio is between 36% and 49% it indicates that they might not have enough surplus left after debt repayment and other bill payments. They may require meeting additional eligibility criteria to be eligible for a loan.
50% or higher: Clients that have a DTI ratio of over 50% spend more than half of their gross monthly income on repaying their debts. In this scenario, creditors may limit the loan amount and charge a very high-interest rate when sanctioning a loan.

Types Of DTI ratio

Creditors look at two DTI ratios when evaluating's a client request for a loan:

Front-end DTI ratio: Creditors use the front-end DTI ratio to calculate the proportion of monthly income that goes towards the repayment of house loans and household-related expenses.
Back-end DTI ratio: Creditors use the back-end DTI ratio to calculate the proportion of monthly income that goes towards the repayment of other debt types such as car loans, education loans and credit card repayments.

Tips To Reduce Debt

Clients with a high DTI ratio may require better debt management strategies. Here are some tips:

Develop a budget. Clients can prepare a monthly budget by calculating their net income, tracking their expenses, setting financial goals and adjusting their spending. It is also essential for them to review this budget regularly.
Keep track of expenses. Clients can use expense management apps or spreadsheets to monitor their daily expenses. This helps them realise their monthly budget goals.
Use income from investments. If clients have fixed deposits, mutual funds or investments in stocks, they can use the income from these sources to pay off their larger debts.
Use savings to pay larger debts. Clients who have substantial savings can use it to pay their high-interest loans. This reduces the overall debt.
Avoid taking more loans. It is crucial for clients to focus on reducing their debt before taking additional loans. They can consider loans with low-interest rates when necessary.

Examples For Calculating The DTI Ratio

Here are two examples to help you understand how to calculate a client's DTI ratio:

Example 1

Here is an example of a client looking to avail of a home loan:

A client working in a corporate job earns a fixed income of ₹12,00,000 per annum and an additional income of ₹15,000 as a freelance consultant per month. The client has a house loan of ₹21,055 per month, a car loan of ₹8,900 and a monthly credit card payment of ₹4000. The client wants to know if they are eligible for another home loan.

Monthly income from corporate job = ₹12,00,000 / 12 = ₹1,00,000
Monthly income from freelance consulting = ₹15,000
Gross monthly income = ₹1,00,000 + ₹15,000 = ₹1,15,000
Total monthly debt = ₹21,055 + ₹8,900 + ₹4000 = ₹ 33,955

DTI ratio = 33955/115000 = 0.295

DTI ratio (%) = 0.295 x 100 = 29.5%

A DTI ratio below 29.5% indicates that the client is eligible for another home loan.

Related: Different High Income Skills

Example 2

Here is another example of a client applying for a car loan:

A client working as a researcher earns a fixed income of ₹9,00,000 per annum. The client has a house loan of ₹20,000 per month and an education loan of ₹26,000. The client wants to know if they are eligible for a car loan.

Gross monthly income = ₹9,00,000 / 12 = ₹75,000
Total monthly debt payment = ₹20,000 + ₹26000 = ₹46,000

DTI ratio = 46000 / 75000 = 0.6133

DTI ratio (%) = 0.6133 x 100 = 61.33%

A DTI ratio above 50% indicates that the client spends more than half their income repaying existing loans. The creditor may not approve the loan since the client is a high-risk borrower. It is advisable for the client to avoid taking additional loans and work towards better financial management.