What does the debt-to-income ratio (DTI) measure?

The debt-to-income ratio (DTI) is a critical metric used in assessing a borrower's ability to manage monthly payments and repay debts. Specifically, it measures the proportion of an individual's monthly debt payments relative to their monthly gross income. This ratio helps lenders evaluate the risk associated with extending credit to the borrower. A lower DTI indicates a better capability to manage monthly payments, while a higher DTI may suggest financial strain or increased risk of default.

In the context of borrowing, lenders often use DTI as a standard measure during the underwriting process because it provides insights into a borrower's financial stability. It balances total monthly debts, such as housing expenses, credit card payments, and loans, against their income, ensuring that the borrower is not over-leveraged. A healthy DTI is typically seen as 36% or lower, which indicates that a manageable portion of the borrower's gross income is allotted for debt payments.

Understanding DTI is essential because it directly impacts loan approvals and the terms offered to borrowers, such as interest rates and loan amounts. Being able to accurately calculate and interpret DTI can guide borrowers in making informed financial decisions when considering new credit obligations.