Calculate your debt-to-income ratio
What is debt-to-income ratio?
Your debt-to-income ratio is a standard measure of your personal finances that lenders often look at before approving a loan. Essentially, it compares your monthly debt payments to your monthly gross income, resulting in the percentage of your income that goes towards debt repayments each month.
This information is often used by banks and other mortgage lenders to determine how easily you will be able to manage your monthly expenses. Therefore, unless you have applied for a mortgage recently or another type of loan, you may never have heard of a debt-to-income ratio before.
Knowing your debt-to-income ratio can be useful for evaluating your overall financial resilience.
However, even if you’re not preparing for a loan and reviewing your finances to give yourself the best possible chance of being approved, knowing your debt-to-income ratio can be useful in other ways. For instance, it can be a great tool for evaluating your overall financial resilience if you are concerned about how much debt you owe.
Why does your debt-to-income ratio matter?
Your debt-to-income ratio shows how much of your monthly income goes towards debt payments. It is often used alongside your credit scores to evaluate how you would be able to handle any additional monthly repayments if you were to be accepted for a loan. So, depending on your debt-to-income ratio, you may or may not be offered the finance you are looking for.
A low debt-to-income ratio is ideal. It demonstrates a positive balance between your debt and income and suggests you will be able to pay off your loan without too much trouble. This is what lenders care about. On the other hand, a high debt-to-income ratio means that you may have too much debt and would struggle to pay off any additional expenses.
Individual banks and financial credit providers will have their own definitions for what is an acceptable debt-to-income ratio and what is too high. But generally, the lower your debt-to-income ratio is, the more likely you are to receive the amount of credit you are applying for.
How do you calculate your debt-to-income ratio?
If you want to calculate your debt-to-income ratio ratio yourself, here’s a quick look at how to figure it out. (These are the calculations behind our calculator at the top of the page).
Add up your recurring monthly debt, including your mortgage payments or rent, car loans, credit cards, student loans or child support, if these apply to you.
Next, add up your monthly income, including your gross wages before tax and national insurance deductions, and any freelance income or investment profits you regularly receive.
Finally, divide your monthly debt by your monthly income and then multiply this figure by 100.
Whether or not the bank or credit provider includes the new loan in this calculation is up to them, so to be on the safe side, include this expense in your debt-to-income ratio calculation tool.
What is a good debt-to-income ratio?
Lenders have different ways of gauging who should or shouldn’t receive a loan. Many will use 36 per cent as a rough top limit, while others will still accept you if your debt-to-income ratio is as high as 55 per cent.
There are two main types of ratios that you need to be aware of:
Front-end debt-to-income ratio
Some lenders prioritise certain debt payments over others. A front-end debt-to-income ratio only covers things like housing expenses, mortgage payments, property taxes and homeowner’s insurance. A 28 per cent to 31 per cent front-end ratio is typically preferable here.
Back-end debt-to-income ratio
For a more comprehensive view of your debt burden, some lenders will want to know your back-end debt-to-income ratio. This includes everything from student loans to child maintenance and credit card payments.
Ways to lower your debt-to-income ratio
Whether you’re trying to bring your debt-to-income ratio down so that you can be accepted for a mortgage, or if you’re simply trying to reduce your debt burden, you’ll need to find ways to improve your debt-to-income ratio somehow. This often involves some strategic long-term planning, but it’s certainly possible.
Below are some common ways to do this but remember, if you are struggling with debt you’re not alone. You might find it interesting to read some of our research on the UK’s attitudes to talking about debt.
Pay off debt
If you can, pay off your debt before you apply for a new loan as this will reduce your debt-to-income ratio. You may decide to aggressively reduce your credit card debts for instance, while tightening your belt over a few months. Or how about consolidating numerous smaller debts into one larger debt with a better rate?
Alternatively, you can borrow money from a family member to pay off certain debt obligations. Or if you need something more drastic, you could always sell a car or move in with your parents for a short period to give yourself the ability to clear some of your debt.
Increase your income
Obviously, this isn’t always possible, but having a larger income each month will lower your debt-to-income ratio. This is something to think about if you are expecting a promotion or thinking about changing jobs in the near future. It may be worthwhile holding off on your application for a mortgage or other loan until you are able to raise your monthly salary.
Equally, you could also pick up additional freelance contracts or a second job if necessary. Or if you have a partner who doesn’t work and looks after the kids, they could consider getting a part-time job and factoring in day care instead. This will involve turning into a joint loan making you both responsible for repayments.
If you have the benefit of time and are planning in advance for an important loan such as a mortgage for your house, it would be worth delaying any additional loans in the meantime until your loan is approved. For instance, taking on a new car hire purchase before you apply for your loan will affect your chances of success.
Pay a larger deposit
A large deposit will lower your debt-to-income ratio. If you have money in savings or tied up in assets, this could be a good time to use this to bring down your debt-to-income ratio before you make a new loan application.
Other important factors
Finally, remember that your application to a loan provider will involve an overall evaluation of your financial capabilities and lenders consider more than just your debt-to-income ratio. They will also look at things like your credit history and score, looking at how you’ve borrowed and repaid any past loans.
Also, mortgage lenders will be interested in your loan to value (LTV) ratio, which looks at how much you want to borrow compared to the value of your property.
An overall review of your finances is the best thing to do if you’re planning on applying for an important loan in the near future. Not only do you need to prove to banks or credit providers that you can manage debt, but you also need to make sure that you can afford any additional payment over the next few years or however long your loan will apply for.