Debt-to-Income Ratio: How to Calculate Yours When You Are Self-Employed
Your debt-to-income ratio is your monthly debt payments divided by your monthly income before tax. Lenders use it to decide whether you can handle another payment.
If you're an employee, the math takes a minute. If you're self-employed, there's a catch: the income a lender counts usually isn't what you earned. It's the profit on your tax returns, averaged over two years.
Here's how to work it out, the catch worked through with real numbers, and what you can do to improve your ratio before you apply for anything.
Two years of profit is the figure a lender starts from. Example data.
The short version
Debt-to-income = monthly debt payments ÷ monthly income before tax × 100.
It counts required payments, not balances and not living costs.
Lenders usually measure a self-employed person's income as net profit, averaged over two tax years.
The lower your ratio, the more room a lender sees.
How to work it out
Add up the required monthly payments on every debt.
Work out your monthly income before tax.
Divide the first number by the second, and multiply by 100.
What counts as a debt payment
Counted | Not counted |
|---|---|
Your mortgage or rent, for most lenders | Groceries, utilities and your phone |
Car loans and leases | Insurance premiums |
Minimum payments on credit cards | A card balance you pay in full each month |
Student loans | Subscriptions |
Personal loans, and loans you've co-signed | What you pay yourself |
Child support or alimony you pay | Savings and retirement contributions |
It's the minimum payment on a card that counts, not what you choose to pay. So this ratio measures what you're obligated to pay, not how well you manage your money.
Same debts, two kinds of income
Here are one person's monthly debt payments.
Monthly payment | Amount |
|---|---|
Mortgage | $1,450 |
Car loan | $380 |
Card minimums | $120 |
Student loan | $210 |
Total | $2,160 |
Now set that $2,160 against two people with similar lives, one employed and one self-employed.
Comparison | An employee | A business owner |
|---|---|---|
How income is measured | Salary before tax | Net profit on the last two tax returns, averaged |
The figures | $78,000 a year | $58,000 and $66,000 |
Monthly income counted | $6,500 | $5,167 |
Debt-to-income ratio | 33% | 42% |
The business owner may have brought in $95,000 from clients each year, but a lender doesn't start there. It starts from the profit line, after every expense she deducted, and averages the two years. That's nine points of difference from exactly the same debts.
The trade-off inside your tax return
Every legitimate deduction lowers your profit, which lowers your tax. It also lowers the income a lender will count. Both are true at the same time.
That's not a reason to skip deductions you're entitled to. It's a reason to know, a year or two before you apply for a mortgage, that the tax return you file is also the document a lender will read. We made the same point about Social Security when you're self-employed: your reported profit is the figure other systems build on.
What lenders tend to look for
There's no single cut-off. Different lenders and loan types use different limits, and a strong credit history or a larger down payment can change them. As a general guide, a lower ratio gives you more room, and many borrowers find that the mid-thirties or below gives them the widest choice. Ask the lender you're considering what they use.
Your profit line is the one that gets averaged. Example data.
Two ways to improve your ratio
The ratio has a top and a bottom, and you can work on either one.
Change | Debt payments | Income counted | Ratio |
|---|---|---|---|
Where she starts | $2,160 | $5,167 | 42% |
Pay off the car loan | $1,780 | $5,167 | 34% |
A new year of profit at $74,000 replaces the oldest one | $2,160 | $5,833 | 37% |
Both | $1,780 | $5,833 | 31% |
Paying off one loan moves the ratio further than a year of growth, because it removes the whole payment at once. A loan with only a few thousand dollars left but a $380 monthly payment does more for your ratio than its balance suggests.
Before you apply for anything
Work out your own ratio using the profit on your last two tax returns.
List your debts by payment size, not balance. For this purpose, the one with the biggest payment and smallest balance is the one to clear first.
Don't open new credit in the months before you apply.
Keep business and personal accounts separate, so your statements are easy for a lender to read.
Ask the lender what they'll count rather than assuming.
What this ratio doesn't tell you
It ignores what you own, what you've saved and what your living costs are. Someone with a low ratio and no savings is in a weaker position than the number suggests. It's a lender's test, not a measure of how you're really doing.
For that, your net worth is the better number. And if you're deciding which debt to pay first, our post on paying down debt while still saving something covers the order.
See every debt in one place, free
La Soglia, the free membership of the Money Mastery System, holds every debt and its balance beside everything you own, personal and business together, with no bank connection and no card. Seeing them on one page is the first step to choosing which to clear.
Bring it to the Collective
Applying for a mortgage while self-employed comes with its own surprises. Ask in the Money Mastery Collective what other members were asked for. The discussion feed is open on the free membership.
Questions we hear
How do I calculate my debt-to-income ratio?
Add up your required monthly debt payments, divide by your monthly income before tax, and multiply by 100.
How do lenders calculate income for the self-employed?
Usually from the net profit on your tax returns, often averaged over the last two years.
What is a good debt-to-income ratio?
It depends on the lender and the loan. A lower ratio gives you more room, and many borrowers find the mid-thirties or below gives the widest choice.
Does my debt-to-income ratio include rent?
Many lenders include your housing payment. Everyday living costs such as food and utilities aren't included.
References
The definition of debt-to-income ratio follows the Consumer Financial Protection Bureau, What is a debt-to-income ratio?. Every figure in this post is our own worked example.
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A note on what this is
This article is educational. The Money Mastery System is an educational tool, not financial software, and nothing here is legal, tax, investment or financial advice. How a lender measures income and which limits it applies vary by lender, loan type and your full financial picture. For guidance on your own circumstances, please speak with a qualified professional who knows them.
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