Understanding Debt to Income Ratio

Debt to Income Ratio

Are you looking to get a better picture of your current financial standing? Calculating your debt-to-income ratio is a great way to monitor your personal finances, and to gain insight to what lenders are analyzing when considering your credit status.

What is a debt to income ratio?

The debt-to-income ratio compares your gross monthly income to the amount of debt (there are some exclusions to deb included such as monthly rent when you do not own your home) you currently owe. Your debt to income ratio can be figured easily if done on a monthly basis.

Here’s an example of how to calculate your debt to income ratio:

  • Say your monthly gross pay is $3,000 before taxes and you pay $240 per month as part of your debt payment for credit cards and loans.
  • You would then divide the amount you pay towards your debt monthly ($240) by the amount you bring home each month ($3,000). 240 / 3,000 = .08
  • Then multiple your answer by 100 to find the percentage. .08 x 100 = 8%

The debt to income ratio for our example is 8%.

Why is understanding my debt to income ratio important?

Debt to Income RatioUnderstanding your monthly debt to income ratio can help you stay in control of your finances and stop you from accumulating more debt than you can afford. Carefully keeping track of your debt to income ration can help you make better decisions regarding credit, and allow you to avoid steep credit card fines/penalties. Creditors review your debt-to-income ratio when they are determining whether they should or should not loan credit.

Having a debt to income ratio above 30% opens up new problems for potential borrowers. It can:

  1. Affect your ability to get larger loans in order to make purchases such as for a new car or home.
  2. Stop you from getting low interest rates and favorable credit terms
  3. Make getting additional credit hard or impossible for you and your family in case of an emergency (e.g. plumbing disaster at your home or car accident).

Debt to income ratios are indicators of financial conditions. Knowing your debt to income ratio can help you plan for the future and keep your debt manageable.

Calculating Income

As a reminder, when trying to calculating the monthly income for your debt to income ratio you should include:

  • Income from your job.
  • Income from child support and alimony.
  • Earnings you have from interest and dividends
  • Income from rental property, side businesses, or another part-time job.

Calculating Monthly Debt Payments

Once you calculate your monthly income, you will have to get a total of your monthly debt payments. When calculating your monthly debt, make sure to include:

  • Bank/credit union loans
  • Student loan payments
  • Loan payments for (appliances, furniture, etc.)
  • Credit card payments
  • Payments for past medical care
  • Any other loans or credit accounts open such as mortgages and car loans

Is my debt to income ratio important?

Yes, knowing your DTI ratio can give you a greater understanding of your finances, and some insight to a factor used by some creditors when deciding whether they should approve a loan or not. As a general rule, the lower your debt to income ratio is, the better your finances are. While everyone’s financial situation is different, having a debt to income ratio lower than 30% is usually desirable.

Many people find themselves in trouble with debt to income ratios rise above 30%. Once you have lowered your debt to income ratio to an acceptable rate, you could receive more favorable terms when applying for credit. Favorable terms such as; lower interest rates, and increased chance of being approved.

Contact Ure Law Firm for a free consultation regarding your financial situation, and learn the best ways to reduce your debt,  and get on top of your finances without filing bankruptcy.