what is a debt-to-income ratio

What Is a Debt-to-Income Ratio and How Do You Calculate It?


If you’re in the market for a loan, you may have heard this term a lot. But what is a debt-to-income ratio, and why does it matter? You don’t need to be a finance guru to understand this important concept. In fact, you can calculate your debt-to-income ratio all on your own in just a few simple steps.

And we’ll get into that in just a second. However, it’s important to understand how this ratio affects your financial health and ability to access products like personal loans. Unfortunately, in the fourth quarter of 2022, the Canadian household debt-to-income ratio was 180.7%.

This is worrying, as a high debt-to-income ratio can indicate to lenders that you have too much debt and can’t make your loan payments on time. On the other hand, a low debt-to-income ratio can make you a more attractive candidate for a loan, as it shows that you are financially responsible and capable of managing your debt.

So, if you’re considering taking out a loan soon, it’s important to know your debt-to-income ratio and work on improving it if necessary. In the rest of this article, we’ll explore more about a healthy debt-to-income ratio, why it matters, and what steps you can take to improve your ratio. 

What is a Debt-to-Income Ratio?

Debt-to-income ratio is the financial metric that determines your ability to take on new debt based on your monthly income. It is a vital indicator of financial health and is one of the key variables lenders and financial institutions use to assess a loan application.

In simple terms: Your DTI ratio demonstrates how much you owe in relation to how much you earn.

Lenders use this ratio as a tool to evaluate whether you’re able to manage additional credit or loans and determine your creditworthiness. A lower debt-to-income ratio indicates that you have more disposable income to cover expenses or save, which improves your chances of securing loans with lower interest rates.

Generally, a debt-to-income ratio of 42% or lower is considered optimal when applying for a loan in Canada. A ratio above this threshold may indicate that you’re financially overextended, impacting your financial stability and future borrowing ability.

How Do You Calculate DTI Ratio?

Calculating your debt-to-income ratio is relatively easy once you know what to do. You need your gross monthly income (before taxes and other deductions are taken out) and the total of your monthly debt payments. Then, follow this calculation:

DTI Ratio = Monthly Debt Payments/Monthly Gross Income 

This will give you a percentage that represents your DTI ratio.

Here’s an example to make things more clear. Let’s say you have a monthly mortgage payment of $1,000, a car payment of $300, and a student loan payment of $200. That’s a total of $1,500 in monthly debt payments. If your gross monthly income is $5,000, you would divide $1,500 by $5,000 to get a DTI ratio of 30%.

While you’re learning to calculate your ratio, consider that there are actually two types of debt-to-income ratios: front-end and back-end.

The front-end ratio includes front-end costs, like necessary housing expenses that include your mortgage/rent, property taxes, etc. On the other hand, your back-end DTI ratio includes all your debt payments. Which do lenders use? They’ll typically look at your back-end DTI ratio.

Why is this important? By understanding and calculating your DTI ratio, you can get a clearer picture of your financial health and make informed decisions about borrowing and managing your debt.

The Consequences of Your Debt-to-Income Ratio

So, again, what is a debt-to-income ratio? Hopefully, by now, you see that it’s a very important measure of how much your monthly income goes toward paying off your debts. This ratio is an indicator of your financial health and can have serious consequences if it’s too high.

If your DTI ratio is too high, lenders may hesitate to approve you for loans or credit cards. This can make it difficult to make large purchases, such as a car or a home. High debt levels can also lead to stress and anxiety and hinder your ability to build wealth for your future.

Should you aim for a low DTI ratio? Always! However, in today’s economic landscape, it’s pretty unfeasible that your DTI ratio is going to be 0%. Here’s what to know about what constitutes a low vs. high DTI ratio and why each one matters.

Low DTI Ratio

Having a low DTI ratio is a sign of financial stability. This means you have more money left over each month after paying off your debts. A low DTI ratio makes getting approved for loans and credit cards easier, and it can lead to lower interest rates and better terms.

However, having a low DTI ratio doesn’t mean you can start slacking off. It’s still important to continue making wise financial decisions. You can use the extra money each month to build your savings, invest in the stock market, or pay down any remaining debt.

High DTI Ratio

On the other hand, having a high DTI ratio can have serious consequences for your financial health. A high DTI ratio means you are spending a larger percentage of your monthly income on debt payments, leaving less money for other expenses.

If your DTI ratio is too high, you may struggle to qualify for loans or credit cards. If you are approved for a loan or a credit card, you may be charged higher interest rates.

How to Improve Your Debt-to-Income Ratio

Improving your debt-to-income ratio is a crucial step in achieving financial stability. And there are several ways to improve your DTI ratio.

Firstly, you need to increase your income. This can be done by getting a higher-paying job or taking on a side hustle. Additionally, it helps if you can reduce your debt payments. You can do this by paying off your debts aggressively. Start by paying off high-interest debts first, then work down the list.

Another way to improve your DTI is to reduce your expenses. You can reduce unnecessary spending by creating a budget and sticking to it. When shopping for goods and services, explore your options to identify deals and promotions that offer better value.

Finally, consider consolidating your debt. A debt consolidation loan can simplify your finances by combining all your debts into a single loan with a lower interest rate. This will help reduce your overall monthly payments, thus improving your DTI ratio over time.

Consider Getting a Fast Loan

Once you know what a debt-to-income ratio is, it’s easier to calculate yours and see where you stand. Is yours too high to qualify for the types of loans you need? Don’t worry; you have other options. And one of the best options is to consider getting a fast loan.

When you need a loan fast, Tekaloan makes applying quick and simple. We proudly serve all Canadians, including those with lower incomes and those who conventional banks may have turned down. With us, you can calculate your debt-to-income ratio and get the funding to cover life’s expenses.

Don’t let financial hardships hold you back — Tekaloan is here to help. Apply now.

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