The Debt-to-Income (DTI) ratio measures how much of a borrower’s gross monthly income remains after paying down debt. Lenders use this ratio to gauge whether the borrower has enough disposable income to take on new debt obligations and still maintain their lifestyle. The ratio measures a borrower’s total required monthly debt payments on consumer credit divided by their gross income from all sources.
While DTI is primarily a consumer lending metric, lenders will use it to evaluate a small business owner’s global cash flow, which includes both business and personal items. This gives lenders a complete financial picture to evaluate the borrower’s risk level and determine if a personal guarantee can offset the risk in case the borrower’s business struggles.
This guide to the debt-to-income ratio will share what it is, how to calculate it, how lenders use it as part of your small business loan application, and tips you can use to improve.
What the Debt-to-Income Ratio Is
The debt-to-income ratio is the percentage of your monthly income before taxes that you’re required to pay toward existing debt. Your income includes all sources of income from your business and from other sources like stocks, dividends, or other jobs. Total debt for the DTI ratio is your consumer debt like mortgage and credit cards, not business debt.
Calculating the Debt-to-Income Ratio
The debt-to-income ratio can be calculated with this formula:
- DTI = Total required consumer debt payments / gross personal income
If your total monthly debt payments are $5,000 and your annual income is $120,000, then your DTI formula looks like this:
- $5,000 monthly debt / ($120,000 annual income / 12 months) = 50%
To calculate your own DTI ratio, first add up your total required debt payments (i.e., regular payments or installments) like these examples:
- Mortgage/rent
- Car loans/leases
- Student debt
- Personal loans
- Minimum payments on credit cards
- Buy now pay later purchases
You don’t need to include expenses such as utilities, cable bills, or cell phone plans that are cancelable. Cancelable items don’t go into the DTI because the ratio measures your ability to cover only required debt and assumes you cut non-required expenses before defaulting on a loan.
Next, find your personal gross income. That is your total taxable income adjusted for non-cash or non-recurring items.
- Use adjusted gross income (AGI) from your tax return
- Add back deductions and non-cash expenses like these:
- Depreciation
- Amortization
- Contributions to tax-deferred retirement plans
- Large one-time business losses
- Subtract one-time and non-recurring income including:
- Capital gains from real estate sales
- Stock investment capital gains and dividend income from stocks you sold
- Other income that you can’t count on in the future
Finally, divide debts by income to get your DTI. Check out the hypothetical example below:
| Item | Amount |
| Mortgage Payment | $2,200 |
| Car Loan Payment | $450 |
| Student Loan Payment | $300 |
| Credit Card Minimum Payment (Total) | $150 |
| Total Debt (Monthly) | $3,100 |
| Adjusted Gross Income (AGI) from Tax Return (Annual) | $95,000 |
| Add-Backs: | |
| + Depreciation | $15,000 |
| + SEP IRA Contribution | $10,000 |
| Subtractions: | |
| – One-time Capital Gain from Stocks Sold | -$5,000 |
| Gross Income (Annual) | $115,000 |
| Gross Income (Monthly) | $9,583 |
| Debt-to-Income (DTI) Ratio | 32.3% |
Pro-tip: Don’t use personal cards for business expenses because they increase your DTI and make your personal guarantees seem less convincing to lenders.
Once you know your own DTI ratio, here’s how to know if it’s good or needs work.
Good Versus Risky Debt-to-Income Ratios
A good DTI ratio is below 36%, but different lenders have their own requirements. So, think of DTI in terms of ranges rather than a single “good” number that you should target.
- Low-risk DTI is under 36%.
- Medium-risk DTI is between 36% and 45%.
- High-risk DTI is 45% or higher.
If your business has a lot of extra cash flow and collateral to secure a business loan, your DTI may not play a large role in approval since lenders will likely see you as a low-risk borrower. However, companies that carry a lot of debt and have weaker cash flow; their medium-risk or high-risk DTIs may cause them to pay higher interest rates, be approved for less than they’re asking for, or simply be rejected.
A good DTI alone won’t get you approved for a business loan, but a bad one can negatively impact your chances of getting financing. That’s because lenders use DTI together with your business’s debt service coverage ratio (DSCR) to get a full financial picture of you as a borrower.
DTI and DSCR in Business Loan Application Approval
Lenders use your debt-to-income ratio together with your business’s debt service coverage ratio (DSCR) for a complete financial picture to determine how risky you are as a borrower. This helps them determine if you’re able to cover debt payments from personal finances if the business declines.
Here’s a comparison of DTI, DSCR, and global cash flow and how they fit into a lender’s decision on your small business loan:
| Formula | Personal or business focused? | How it impacts small business loan applications | |
| DTI | Total debt payments / Gross personal income | Personal | Shows financial discipline of the owner and assures the lender you’ll meet personal guarantees if needed |
| DSCR | Business earnings before depreciation, amortization, interest, and taxes (EBITDA) / Total business debt payments | Business | Calculates how much extra cash flow your business has to absorb new debt payments including higher payments from rising interest rates |
| Global cash flow | (Total personal income + EBITDA) / (Total personal debt payments + total business debt payments) | Both | Gives lenders the full picture of an owner’s ability to repay the loan |
Preparing for an Upcoming Business Loan Application
To increase your chances of getting approved for a business loan, you’ll want to lower your debt-to-income ratio. This means having a plan to reduce debts and cut unnecessary expenses beginning at least 90 days before you apply.
First, start by not applying for any new debts including credit cards and lines of credit. Next, avoid large purchases that reduce income or require monthly payments. Now think about what you can do in the next 30, 60, and 90 days, including removing business expenses from personal credit cards, documenting new revenue streams including side-hustles that take off, and recording any dividends or increases in stock values you invest in.
Your DTI ratio shows the percent of the total gross monthly income you pay toward personal debt. Small business lenders use your DTI together with your business’s debt service coverage ratio to view your global cash flow. This helps them determine your overall risk as a borrower.
A low DTI under 36% helps you get approved for business loans in many cases and makes your personal guarantee stronger. Medium-risk or high-risk DTIs don’t automatically disqualify you from getting a new small business loan, especially when your business has a high DSCR. But if your DTI is medium-risk or high-risk, use the 30/60/90-day plans explained above to improve it.
National Funding does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal, and accounting advisors.
