Debt-to-Income Ratio

Lenders use the debt-to-income ratio to judge whether a borrower can afford more debt. It is calculated by adding up monthly debt payments, such as mortgage or rent in some versions, car loans, student loans and minimum credit card payments, and dividing by gross monthly income.

For example, if you earn 5,000 a month before tax and your monthly debt payments total 1,500, your debt-to-income ratio is 30%. That means 30% of your income is already committed to repaying debt.

A lower ratio suggests more room in the budget and less risk for the lender. Many lenders become cautious when the ratio rises above roughly 35% to 45%, depending on the type of loan and local rules, though exact limits vary.

The ratio can be improved in two ways: by reducing monthly debt payments, for instance by paying off a loan, or by increasing income. Because it is based on payments rather than balances, paying off a small loan entirely can improve the ratio more than partly paying down a large one.