What Your Debt-to-Income Ratio Can Tell You

While some debt is necessary for most people, having too much of it can be quite problematic. Shouldering an abundance of monthly payments can restrict your ability to save, cause anxiety and impede your ability to get a home loan.

 

After all, your monthly debt payments balanced against your monthly income is one of the key qualification factors lenders consider. It’s something to which you should pay close attention as well.

 

Here’s what your debt-to-income ratio can tell you.

 

Calculating Your Ratio

As we mentioned above, your debt-to-income ratio is a measure of how much you owe each month against how much you earn. To find yours, make a list of all of your monthly obligations such as rent, student loans, car loans, credit cards (based on the minimum monthly payment) and any other debts you may have such as child support, alimony, or the like, and add them up to find their sum.

 

You can exclude utilities, insurance, groceries and taxes.

 

Once you have that monthly total, divide it by your monthly gross income (your pay before deductions) and multiply that quotient by 100. The resulting figure will be the percentage of your income currently being employed to service your debts.

 

As an example, let’s say you make $6,000 a month before taxes and your debts total $2,000. When you divide 2000 by 6000 you’ll get a quotient of .33. Multiplied by 100, .33 gives you a debt-to-income ratio of 33 percent.

 

What’s a Healthy Ratio?

In most cases, mortgage lenders will work with you if credit score is strong and your ratio is 43 percent or less, as you will usually be eligible for what’s known as a Qualified Mortgage.

 

If your debt-to-income ratio is 50 percent or above, you might want to consider consulting a firm like Freedom Debt Relief to look at some strategies such as debt consolidation to get your obligations more in line with your income, before things get too much farther out of hand.

 

Tips for Lowering Your Ratio

Logically speaking, the best way to lower your debt-to-income ratio is to reduce your spending and pay down your debt. However, given it’s ratio, your other option is to increase your income. Perhaps you can get a raise at work, pick up a part time job or  some freelance gigs.

 

Other strategies include making extra credit card payments to reduce your balances and therefore your minimum payments. You should avoid making big purchases on credit until you’ve qualified for the loan you’re seeking. You should also sidestep opening new lines of credit.

 

Why It Matters

Your ratio is a useful measure of your overall financial health. If it’s high, you’re in danger of becoming overextended. A large unexpected expense could push you over the edge. Or worse, a sudden loss of income could land you in a situation in which you can not afford to service your debts at all.

 

What’s more, while your debt-to-income ratio doesn’t factor directly into the calculation of your credit score, it does have an effect on it. One of the measures credit rating agencies use is the amount of your available credit currently in use.

 

Remarkably, most people don’t think about what the debt-to-income ratio can tell you until they’re trying to qualify for a mortgage or some other major loan. However, keeping a watchful eye on it will help you avoid money problems and enjoy financial peace of mind.

About the Author