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How would you assess your financial situation? Check out this guide to figuring out your debt-to-income ratio and the importance of knowing your DTI ratio.
You have a $48,000 salary and think you’re behind. But if you’ve paid all your unsecured debts, that salary may be a lot better than earning six-figures with a crippling debt-to-income ratio.
A debt-to-income (DTI) ratio is a percentage comparing your debt payments against your gross income. Lenders look at this ratio to assess your “creditworthiness,” meaning how likely you are to repay your debt. But how do you calculate and interpret your debt-to-income ratio? Do credit bureaus consider it when calculating your credit score?
We’ll cover everything you need to know about DTI ratios, including why you should care about this number.
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Which should you choose?
A DTI ratio is a tool that indicates the balance between your income and debt. It tells you how much money you owe for every dollar you earn.
A favourable (low) DTI ratio might demonstrate your ability to manage your monthly debt payments. On the other hand, a high DTI ratio might indicate financial troubles and difficulty paying debts.
Don’t worry; you don’t need to consult an accountant to find out your debt-to-income ratio. You just need a few minutes and these simple steps:
$2,500 ÷ $4,000 = 0.625
0.625 x 100 = 62.5%
Voila! You have your debt-to-income ratio. In the example above, that ratio translates to $0.63 owed per month for every $1 made.
After reading the example above, you might wonder: Is 62.5% a good or bad debt-to-income ratio? We’d say it’s good compared to the national average, which is $1.83 for every $1 earned (ouch!). But a lender might not agree.
Credit Canada offers some helpful guidelines for assessing your DTI ratio:
| Debt-to-income ratio | Rating |
|---|---|
| <34% | Good |
| 35% to 45% | OK |
| 46% and up | Not great |
Now, what do these classifications mean for your day-to-day finances? Let’s find out.
Your debt-to-income ratio affects your ability to borrow and your general financial situation. Here are a few reasons why it matters:
Lenders don’t typically lend to someone overwhelmed with debt. They might assume you can’t handle your monthly payments on a new loan if you have a high DTI ratio. Canadian lenders tend to prefer borrowers with a maximum 42% DTI ratio.
Our finances are a hodgepodge of different figures—it’s not always easy to make sense of them all. But the DTI ratio helps you understand where you are in terms of debt management. It’s an easy ratio that indicates your general ability to pay your debts, which is helpful in financial planning.
Debt-to-income ratio does not affect your credit score, according to credit reporting agency Equifax. However, lenders still consider it alongside your credit score to assess your creditworthiness.
It’s also worth noting that your credit utilization ratio does affect your credit score. That calculates how much credit you’ve used against your available credit.
But is the DTI ratio the be-all, end-all of your borrowing ability? Not quite.
DTI ratios are not an accurate analysis of your overall personal finance situation, as they don’t distinguish between different types of debt.
This is a considerable limitation because not all debts are equal. Someone with a high debt-to-income ratio due to a mortgage has an asset that may appreciate over time—a better situation than someone with a high DTI ratio because of immense credit card debt.
Another limitation: The DTI ratio doesn’t account for low-interest versus high-interest debt. For example, two people could have the same monthly debt payment amounts but one has it on a credit card, and the other owes on a line of credit—the latter has traditionally lower interest rates.
That’s why lenders use many factors and tools to assess creditworthiness, including the credit utilization ratio we just mentioned.
Your DTI ratio helps you honestly assess your debt picture. It’s a helpful tool for financial planning, but also has some power in determining your eligibility for a loan.
If you have a high DTI ratio, don’t worry, you’re not the only Canadian. And there is support available to help you pay down debt.
Talk to one of Credit Canada’s certified credit counsellors to discuss budgets, debt, and DTI ratio. We’ll sit down and review your budget and credit report together. Then, we’ll figure out a foolproof plan to save your money, reduce your debt, and stop collection calls.
This article is written by Mike Bergeron, a certified Credit Counsellor and Financial Coach with Credit Canada, with over 15 years of experience in the financial industry. He has helped thousands of clients over the years in terms of consolidating their debts, budgeting their spending, and educating them on how to recover from some of their past financial challenges.
Credit Canada is Canada’s first and longest-standing credit counselling agency. For more than 50 years, Credit Canada has been helping Canadians lead healthy financial lives, achieve their goals, and improve their quality of life through financial education and debt resolution. As a national, non-profit organization Credit Canada has helped thousands become debt-free and achieve financial wellness.
If you are struggling with debt, you can contact Credit Canada for free credit counselling services.
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I think you might have gotten mixed up on comparing DTI percentages to the national average. The example in this article is comparing Monthly DTI (62.5%) to the national average of Total DTI (183% which includes total mortgage borrowed): person making $100k/yr salary with a $183k mortgage equals to $1.83 DTI, and not that they are spending 183% of their monthly income each month. This person who makes $100k a year isn’t spending $6900 more than they make every month.