What You Need To Know About Debt-to-income Ratios

Debt is a problem that plagues many of us today. If unmonitored, your debt can grow at an alarming rate and the next thing you know you’re finances are in shambles.

If you want to identify your overall financial situation and keep your debt in check, you need to establish your debt-to-income ratio. Your debt-to-income is the relation between what you owe and what you make. To calculate your ratio, take your monthly debt payments (such as house, credit card, and payments) and divide it by your monthly take-home income. Monthly debt payments are considered anything you can’t pay off in 6 months. Items such as monthly food expenditures, utility bills, and entertainment expenses should not be considered when calculating your debt-to-income ratio. These expenses can be paid off within a month’s time. A car payment, however, can not, so be sure to include that amount in your total monthly debt payment. Anything that is a payment for a monthly service or one-time expense does not need to be considered when establishing your debt-to-income ratio.

Example of Debt-to-Income

If you make $4,000/month, this is your monthly income. If you have a car payment of $400/month and a house payment of $1,200/month, and a boat payment of $250/month, when you add these monthly amounts together, the end result is your monthly debt/fixed expenses.

To establish your debt-to-income ratio, divide your monthly debt payment by your monthly income. The end result is your debt-to-income ratio.

Mo

thly income: $4,000
Monthly debt payment: $1,850
Debt-to-income ratio: $1,850/$4,000 = 46%

After you calculate your debt-to-income ratio, it’s time to discover what your ratio is telling you. If you have a ratio of 10% or less, it means you have a great debt-to-income ratio, meaning your income is significantly more than what you owe. However, if you have a debt-to-income ratio of 55% or higher, it means you are taking on too much debt in relation to your income – anything over 55% is considered very risky since it will be difficult to continue to cover your monthly debt obligations with your current income.

Debt-to-Income Ratio and Lenders

Lenders calculate and analyze your debt-to-income ratio to determine the size mortgage you can afford. In fact, your DTI and your loan-to-value (LTV) are frequently the most important numbers that lenders look at when quoting you a mortgage amount and interest rate.

So as you can see, your debt-to-income ratio can tell you a lot about your debt and your chances of qualifying for a mortgage loan. So in the end, the best thing to do is to keep your debt under control and not to take on too much debt. It could hinder your ability to qualify for a mortgage and send your finances plummeting.



By: Brad Stroh -