How is the Debt-to-Income ratio calculated?

The Debt-to-Income (DTI) ratio is a key financial metric used to assess an individual's ability to manage debt payments relative to their income. The correct method for calculating this ratio involves taking the total monthly debt payments a borrower is obligated to make — such as mortgage, car loans, credit card payments, and other monthly debts — and dividing that amount by their gross monthly income.

This calculation gives lenders insight into how much of a borrower’s income is being spent on debt payments, which is crucial for evaluating the risk involved in extending credit or approving a loan. A lower DTI ratio typically indicates a better financial position and a higher ability to meet debt obligations, while a higher ratio may raise concerns about financial stability and ability to manage additional debt.

Other methods outlined in the choices do not accurately represent how DTI is calculated; for instance, merely subtracting total debt from total income does not reflect the ongoing monthly obligations and fails to consider income dynamics effectively. Therefore, the method of dividing total monthly debt payments by gross monthly income provides the clear and standardized measure needed for financial assessments.