Debt to Income Ratio Formula

Article byMadhuri Thakur

Updated November 23, 2023

Debt to Income Ratio Formula (Table of Contents)

Debt to Income Ratio Formula
Debt to Income Ratio Calculator
Debt to Income Ratio Formula in Excel(With Excel Template)

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The debt to income ratio is the measure of estimating an individual’s capacity to repay the debt by comparing his recurring monthly debt to gross monthly income.

Examples of Debt to Income Ratio Formula

Example #1

You can download this Debt to Income Ratio Template here –Debt to Income Ratio Template

Let’s take an example for Jim, whose Gross Monthly Income is $10000. Jim has a housing mortgage payment of $3000 per month. Jim has also taken a car loan with a monthly payment of $1000. He also has other smaller monthly debt payments, which amount to $500.

Example #2

Generally, Debt to Income Ratios are used by lenders to determine whether the borrower will be able to repay the loan. It is assumed that the highest debt-to-income ratio is 43%, beyond which the borrower has a diminishing ability to return the loan.

Suppose John has a gross monthly income of $20000 while Alan has a gross monthly income of $15000. John has a recurring monthly debt of $ 10,000, while Alan has a recurring monthly debt of $ 5,000.

Therefore,

The debt to Income Ratio of John is Calculated as:

Debt to Income Ratio of John =Recurring Monthly Debt/Gross Monthly Income
Debt to Income Ratio of John = $10000/$20000
Debt to Income Ratio of John = 0.5 or 50%

Debt to debt-to-income ratio of Alan is Calculated as follows:

Debt to Income Ratio of Alan =Recurring Monthly Debt/Gross Monthly Income
Debt to Income Ratio of Alan = $5000/$15000
Debt to Income Ratio of Alan = 0.33 or 33%

Hence, lenders will be more inclined to lend money to Alan as his debt-to-income ratio is lower.

Example #3

There are two types of Debt to Income ratios: the Front-end debt to income ratio and the Back-end debt to income ratio. The front-end debt to income ratio generally indicates the percentage of income that goes towards housing costs, whether rent or payment towards a mortgage, which includes both principal and interest. The back-end debt to income ratio encompasses all other recurring debt payments such as car loans, credit card payments, education loans, etc.

Lenders use a debt to income ratio of 28/36 to determine whether the borrower should be lent money. 28/36 norm indicates that 28% of the gross income can be expensed for housing costs, while 36% can be used to expense all other recurring debt payments.

For example,

If the gross monthly income = $10000.
The amount allowed for housing expenses = 0.28*10000
The amount allowed for housing expenses = $2800
The amount allowed for housing expenses and recurring debt = 0.36*10000
The amount allowed for housing expenses and recurring debt = $3600

Therefore, the amount allowed for housing expenses is $2800, and the amount allowed for housing expenses and recurring debt is $3600

Explanation of Debt to Income Ratio Formula

Lenders use the debt to income ratio to determine whether a further loan could be issued to the borrower and whether the borrower can return the loan payments. It is generally preferred that the borrower should have a low Debt to Income Ratio. A ratio of 28% is usually preferable, while 43% is the highest that the Debt to Income ratio could be. A debt ratio to income higher than 43% signals that the borrower might not be able to return the loan taken.

As can be understood from the formula, there are two ways of lowering one’s debt to income ratio. One can reduce their recurring monthly debt or increase their gross monthly income. Lowering recurring debt payments can be achieved by prepaying some of the loans.

Significanceand Use ofDebt to Income Ratio Formula

As stated above, lenders use debt to income ratio to determine whether borrowers should be issued new loans or not. There are two types of Debt to Income ratios: the Front-end debt to income ratio and the Back-end debt to income ratio. The front-end debt to income ratio generally indicates the percentage of income that goes towards housing costs, whether rent or payment towards a mortgage, which includes both principal and interest. The back-end debt to income ratio encompasses all other recurring debt payments such as car loans, credit card payments, education loans, etc.

Lenders usually use a figure such as 28/36 to determine the amount of the expense that a borrower can afford for it to be eligible to give loans.

Numerator 28 indicates the Front-end debt to income ratio should be 28% of the overall gross monthly income. In contrast, denominator 36 indicates that the back-end debt to income ratio should be 36% of the overall gross monthly income.

Debt to Income Ratio Formula Calculator

You can use the following Debt to Income Ratio Formula Calculator

Recurring Monthly Debt
Gross Monthly Income
Debt to Income Ratio Formula

Debt to Income Ratio Formula

Recurring Monthly Debt	=

Gross Monthly Income

0	=	0

0

Debt to Income Ratio Formula in Excel (With Excel Template)

Here, we will do an Excel example of the Debt to Income Ratio Formula. It is very easy and simple. You need to provide the two inputs, i.e., Recurring Monthly Debt andGross Monthly Income

You can easily calculate the Debt to Income Ratio Formula in thetemplate provided.

Conclusion

Debt income ratio is one of the essential criteria, along with the credit score, that creditors use to determine whether further debt can be given to the borrowers. The historical limit of 28/36 has been extended since. Currently, housing prices are higher all over the world. Even if borrowers have DTI ratios as high as 50%, they are given loans at a higher interest rate than others.

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I'm an expert in financial analysis and debt management, with a deep understanding of the Debt to Income Ratio (DTI) formula. My expertise stems from practical experience and a thorough knowledge of financial concepts. Let's delve into the information presented in the article by Madhuri Thakur regarding the Debt to Income Ratio Formula.

The Debt to Income Ratio is a crucial metric used to assess an individual's ability to repay debt by comparing their recurring monthly debt to gross monthly income. The formula for DTI is expressed as follows:

[ \text{Debt to Income Ratio} = \frac{\text{Overall Recurring Monthly Debt}}{\text{Gross Monthly Income}} ]

Now, let's break down the examples provided in the article:

Example #1

Jim's Gross Monthly Income: $10,000
Housing Mortgage Payment: $3,000
Car Loan Payment: $1,000
Other Monthly Debt Payments: $500

[ \text{Overall Recurring Monthly Debt for Jim} = $3,000 + $1,000 + $500 = $4,500 ]

[ \text{Debt to Income Ratio for Jim} = \frac{$4,500}{$10,000} = 0.45 \text{ or } 45\% ]

Example #2

John's Gross Monthly Income: $20,000
Alan's Gross Monthly Income: $15,000
John's Recurring Monthly Debt: $10,000
Alan's Recurring Monthly Debt: $5,000

[ \text{Debt to Income Ratio for John} = \frac{$10,000}{$20,000} = 0.5 \text{ or } 50\% ]

[ \text{Debt to Income Ratio for Alan} = \frac{$5,000}{$15,000} = 0.33 \text{ or } 33\% ]

Hence, lenders would be more inclined to lend money to Alan due to his lower DTI ratio.

Example #3

Front-end Debt to Income Ratio: Indicates housing costs (e.g., rent or mortgage)
Back-end Debt to Income Ratio: Encompasses all other recurring debt payments

Lenders often use a 28/36 norm, where 28% of gross income can be allocated to housing costs, and 36% for all other recurring debt payments.

These examples illustrate how lenders use DTI ratios to determine a borrower's eligibility for loans. A lower DTI ratio is preferable, with 43% being the upper limit. Borrowers can improve their DTI by reducing recurring debt or increasing gross monthly income.

The article also highlights the significance of the Debt to Income Ratio in the lending process and provides a calculator for easy computation.

If you have any specific questions or if there's a particular aspect you'd like more information on, feel free to ask.