Ratios! Perhaps you remember learning something about them in school; or, like a lot of things from those carefree and debt-free days, maybe you’ve forgotten all about them.
However, with the news that Canada’s debt-to-income ratio, or DTIR, has reached an all-time high of 171 percent, it may be a good time to get reacquainted with them.
What is a debt-to-income ratio?
Debt-to-income (DTI) ratio is simply the amount you owe versus the amount you earn. (If you’re married and both partners work, it may be referred to your debt-to-household-income ratio.)
The good news for anyone who’s mathematically challenged is that calculating your DTI ratio isn’t complicated, so no online DTI calculator here. (Plus, being able to work through the math yourself is a handy skill to have in your budgeting toolkit.)
How is my DTI ratio calculated?
You can calculate your debt-to-income ratio in just three easy steps:
Add up all the fixed debt payments you make each month. This includes your mortgage or rent, condo fees, car loan payments, minimum payments on credit cards and student loans, and any other loan payments you have.
Let’s say you get a grand total of $2,000. This figure would be your monthly fixed debt.
Step 2Divide your total monthly fixed debt from Step 1 by your total monthly earnings. It’s important to note that lenders use your gross monthly income (pre-tax earnings), not your net income or “take-home" pay.
So, let’s say your gross monthly income is $4,000 and your total monthly fixed debt is $2,000. You would divide $2,000 by $4,000, which gives you 0.50 ($2,000 / $4,000 = 0.5).
Multiply the figure from Step 2 by 100.
That’s ($2,000 / $4,000) x 100 = 50.
That means your DTI ratio is 50 percent. In other words, you owe 50 cents for every dollar you earn, which is a whole lot better than the national average. (The average Canadian owes more than $1.70 for every dollar they earn, ouch!)
How does my DTI affect my credit score?
Often, loan-hopefuls get so hung up on their credit score that they completely forget (or don’t realize) that their debt-to-income ratio is also important. Your DTI ratio is heavily scrutinized by lenders looking to make a decision on whether or not to give you a loan, so knowing your DTI can give you an idea of your approval odds. If it’s low, you’re good to go; if it’s high, you can take steps to bring it down before you run the risk of getting turned down by a lender.
So, what’s the magic number? Most Canadian banks and lenders seem to agree on 40 percent, give or take a percentage or two.
Here’s a breakdown of ratio scores and where they position you on the DTI scale. It's important to remember that every bank or lender is different, so use this only as a general guideline.
34% or less: When it comes to finances, you’re hitting your goals like Wayne Gretzky. Lenders will view you as responsible with money and a low-risk customer.
35% to 45%: Not bad! Sure, there’s room for improvement, but you’re also managing your debt admirably.
46% or more: You’re in the danger zone now, meaning lenders might tune you out. If you’re unable to lower your DTI ratio on your own, you may need to consider a co-signer to get the loan you need.
How can I lower my DTI ratio?
The easiest way to lower your DTI ratio would be to increase your income—but your boss probably isn’t going to give you that $10,000 raise just because you asked nicely. So the next best thing you can do to lower your DTI ratio is, not surprisingly, lower your debt.
Have a savings account? Savings aren’t factored into your DTI ratio, so dipping into them will not negatively impact it. You might want to consider paying down some credit card debt using your savings, which will save you money on interest too. (Credit card debt is considered “bad debt” by lenders, and it’s likely to have the highest interest rate, so reducing that debt is a win-win for you!)
As the national DTI ratio continues to rise, lowering yours can make you look better, feel better, and put you in a better position should you need a loan down the road.
If you have more questions about your DTI ratio or your credit situation, Credit Canada is here to help. You can speak with an experienced credit counsellor today by calling 1-800-267-2272 and take back control of your financial future.