Why your debt to income ratio is important

Your debt to income ratio shows how much of your monthly income is spent on repaying your debts. It gives you a good indication of whether the amount you're spending is a healthy amount and whether it will continue to be affordable for you. You'll also see it frequently abbreviated to DTI or DTIR.

The financial industry, especially banks, uses it to get an idea of how easily you'll be able to pay back any money they lend you.  They'll therefore look closely at your debt to income ratio to decide if you're a safe risk to lend to. Responsible lenders also see it as a way to try and help protect you from over-extending yourself financially.

You can also use it too.  It’s a really useful and easy-to-use tool for performing a quick financial health-check – particularly if you’re thinking about whether or not to take on a new loan or other form of debt.

How to calculate your debt to income ratio

It's really pretty easy. Just follow these simple steps.

Step 1: List your regular debt payments

List and add-up all your regular monthly outgoings for debt related payments. In other words, include things such as loans and credit cards but NOT casual spending items such as food, clothes, petrol and electricity.

If you have payments that vary such as credit cards, then use the minimum monthly repayment figure.

For example:

Step2: Calculate your monthly income

Do exactly the same for your monthly income such as wages, salaries and social benefits. Do NOT include things that are unpredictable such as the odd gift of money from parents etc.

So, perhaps:

Step 3: A simple calculation

Divide the debt payment total by the income total. Then multiply the result by 100. You should get a two-digit answer.

In this case the sum is simply £700 / £2000 x 100 giving a result of 35 (%).

You're done! The figure of 35% is the debt to income ratio in this case.

What does this mean to you and others?

As a very rough guide, if your DTI is around 40% or below then you’re probably looking reasonably healthy in terms of your income versus your debts.

Many lenders will be happy to lend you money - though this doesn't mean you’ve got a green light for more borrowing! Debt is typically expensive and it’s usually a good idea to avoid it where possible.

If you’re between 40-50% then you should consider this a strong amber warning light in terms of trying to borrow more. You may need to start thinking about how to reduce your debts because you’re spending a lot of your money paying back what you already owe.

Some lenders may not advance money for people in this band. Others that do may charge you a high price because you’ll be seen as higher risk.

If your figure is above 50%, then this may be an indication that you have too much debt and that action to reduce it is highly advisable. It should also be a red-light ‘STOP’ for you in terms of taking on further debt.

In practice, once you have a DTI of more than 50% you may struggle to obtain loans from reputable lenders.

Should I panic if my debt to Income ratio is high?

No, absolutely not! It does not mean that you’re bankrupt or suddenly going to find the bailiffs at your door.

Note also that the DTI is NOT a full financial health-check. For example, it doesn’t take into account your assets. You may, for example, have very large cash savings that are not being taken into account.

What a high DTI is telling you is that you’re spending too much of your monthly income on paying back your debts and that this may not be sustainable in the longer term.

If you find that you do have a high debt to income ratio, it is usually a good idea to start taking some immediate debt reduction steps.