Flow of the Debt to Income Ratio Formula article
DTI or Debt to Income Ratio Formula
Before an investor decides to loan a certain amount to a firm, the investor needs to know that the firm is earning enough monthly to pay off his lending amount. This can be true for an individual borrower as well.
Let’s have a look at the formula of debt to income ratio –
Explanation of DTI or Debt to Income Ratio Formula
If an individual takes a loan, the lender needs to know whether the individual is capable enough to pay off the monthly due amount.
For example, if an individual wants to buy a television on equal monthly installments; she needs to produce proof of her monthly income to the lender so that the lender can check whether the individual has been earning enough to pay off the monthly debt amount.
This scenario also happens with a firm too. If a small firm goes to a bank and asks for a loan, the bank will first see how much the firm earns yearly, quarterly, and monthly. If the profit of the firm is enough, the bank will accept the loan proposal.
And to calculate whether an individual or a firm is worthy of a loan, we use debt to income ratio formula.
Use of DTI or Debt to Income Ratio Formula
Debt to income ratio formula is used very broadly. As for example, if you apply for a personal loan, the lender will check the debt to income first.
If you apply for a credit card, the lender will check whether you have enough monthly earnings to pay off the due amount. Even for the mortgage acceptance, debt to income is used. The most generic form of checking whether an individual is worthy of getting a mortgage loan or not is to see whether the total debt to the monthly income ratio is 36% or less. If the total debt payment is around 50%, the individual may not be worthy to get a mortgage loan.
DTI / Debt to Income Ratio Formula
Let’s take an example to illustrate debt to income ratio (DTI) formula.
David has applied for a credit card. He finds out that credit card would very useful for him for smaller purchases. The credit card company asks David for a proof of his monthly income. The credit card company finds that David earns around $10,000 per month. After few days, the credit card company informs David that he is eligible for the credit card.
From this example, we can interpret that David is eligible for the credit card because the expected monthly debt payment is far less than David’s monthly income.
If we use the formula, we will understand this clearly.
- Let’s say that the expected monthly debt payment would be $2000 (credit card companies have restrictions that an individual can only expend a certain amount).
Using the formula of debt to income ratio, we get –
- Debt to Income = Expected monthly debt payment / David’s monthly income = $2000 / $10,000 = 20%.
Since the expected monthly debt payment is just 20% of David’s monthly income, the credit card company decides to go ahead with David’s application for a new credit card.
DTI – Debt to Income Ratio Calculator
You can use the following DTI / Debt to Income Ratio Calculator
|Debt to Income Ratio Formula =||
DTI / Debt to Income Ratio in Excel (with excel template)
Let us now do the same example above in Excel.
This is very simple. You need to provide the two inputs of Expected monthly debt payment and David’s monthly income.
You can easily calculate the ratio in the template provided.
You can download this DTI / debt to income ratio template here – Debt to Income Ratio Excel Template
This has been a guide to DTI / Debt to Income Ratio Formula, practical examples, and Debt to Income ratio calculator along with excel templates. You may also have a look at these articles below to learn more about Financial Analysis –
- Debt Ratio Calculator
- Asset to Sales Ratio Calculator
- Debt Coverage Ratio Calculator
- Simple steps to manage your money
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