The debt-to-income ratio (DTI) is a financial metric that compares a person’s monthly debt expenses to their monthly gross income. It helps to determine the percentage of income used to pay off debt.

To get your debt-to-income ratio, add all of your monthly debt obligations. Typical debts include personal loans, car loans, student loans, and credit cards. Housing costs are also included in the calculation, whether you rent or you pay a mortgage. You owe rent to your landlord or mortgage to a bank. Aside from the principal, interest on mortgage payments, property taxes, home insurance, and association fees are also included in the equation. Once you have your monthly debt payments total, you should sum your income before taxes.

If you only have one source of income, this calculation will be easy. But if you have other substantial streams of revenue such as an investment portfolio, you also need to include these in your income calculation. Divide the total monthly debt by the gross monthly income to arrive at a decimal figure. You can multiply this number by 100 if you want a percentage figure. The number you arrive at is the percentage of your income that is claimed by your debts.

For example, you live in an apartment and pay $1,000 a month. Your monthly car loan payment is $300. You pay $100 on your credit cards while $200 goes to your student loan. We get a total of $1,600 for debts.

Now let’s say you are employed and earn $60,000 a year. Your monthly income will be $5,000. Divide the total monthly debt of $1,600 by $5,000 and you get 0.32 Your debt-to-income ratio is 32%. This means that 32% of your income goes toward debt payments each month. So you have your DTI, and now you might ask why it’s important.

Your debt-to-income ratio is a useful figure in several aspects of your finances. Here’s why you should give more consideration to this number.

Whether you are obtaining a mortgage to purchase a home or refinancing an existing mortgage to get a better interest rate, the fact remains that home loans involve large amounts of money to be repaid over many years. Mortgage providers consider more factors compared to a lender who is loaning out $5,000 for a personal loan.

One factor involved in their consideration is your debt-to-income ratio. Lenders want to know your borrowing habits and that your current sources of income can cover the monthly payments required by the mortgage. Mortgage banks consider two types of DTIs, front-end and back-end DTIs.

Front-end DTI includes housing-related costs such as mortgage payments, insurance premiums, property taxes, and association dues. Lenders still calculate for Front-end DTIs but they will be more concerned about the Back-end DTI.

The back-end DTI is the ratio that we arrived at in our earlier calculation. It includes all your debts and income. Lenders see this back-end DTI as a symbol of a borrower’s ability to pay for mortgage payments. Mortgage banks prefer borrowers with less than 36% back-end DTI. However, this will still vary depending on the bank or institution you talk to. The FHA for instance will accept borrowers with DTI of up to 57%.

The reason DTI is important for you is the same reason lenders include it in their assessments. It tells us how much you have for items that are not payment obligations. Someone with a $100,000 annual income and $70,000 in debt is not better off than someone with only $50,000 annually but only $10,000 in debt. The one with the smaller debt has a stronger capability to make complete payments.

A non-zero ratio is not completely bad. In fact, loans are used even by the most financially responsible. It all boils down to how you handle the funds and the payments that go toward those loans. A loan can give you a mode of transportation, a roof over your head, or the ability to learn advanced skills in school.

The easiest way to get a lower DTI ratio is to pay your debts. Find the smallest debt amount and pay it off. This will lower your total debt and in turn your total DTI ratio. And once you have that out of your obligations, you get to allocate more of your income for bigger loan amounts.

Refinancing and consolidating debts gives you a couple of advantages. First, your debts are combined into one account where you send a single payment. This is also easier to track and manage compared to dealing with multiple creditors. Second, debt refinancing and consolidation can give you a smaller interest rate, lower monthly payments, and longer terms as long as you do it right. There are loan aggregation platforms such as Credible where you can receive prequalified offers from lenders without affecting your credit score.

You can do new calculations every month or every quarter to motivate yourself and keep on track. Monitoring the numbers will also help you notice problems earlier and find a resolution. The DTI ratio is an important figure if you want to take a mortgage or other type of loan in the future. It can also be used as an indicator of your credit or financial health

You might have a huge income but that positive will be diminished if you have a huge debt amount as well. Keep track of the numbers regularly and take steps if you notice it rising.