Debt to Income Ratio
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Calculating your debt-to-income ratio is another way to assess the state of your finances. The ratio compares the amount of your monthly debt (not including your rent or mortgage payment each month) to your total monthly income. A debt-to-income ratio that is under 20% is considered to be a good number. A ratio that is higher than 20% means that you have too much debt relative to your income and creditors may be unwilling to offer you attractive terms on any credit you may apply for. As a result, it will cost you more to use credit and big ticket items like a home or a car may be beyond your financial reach. If your ratio is 20% or more, paying down your debt will lower the ratio and make you more attractive to creditors.
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Calculating your debt-to-income ratio is not difficult. Here's how:
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- Using your budget, add up all sources of your household's monthly income, including income from work, tips and commissions, any alimony or child support you are receiving, rental income, government benefits, and so on. If your spouse works outside the home or receives income from other sources, include that income too in order to come up with a Total Monthly Income figure (When you add in income from work, use your net income figure, which is the amount of money you actually take home each month.)
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- Referring to your budget to make certain that you do not overlook any of your debts, add up all of your monthly debt payments based on the minimum payments due for each debt. The total is your Total Monthly Debt figure. (Don't include the amount of your rent or mortgage)
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- Divide your Total Monthly Debt by your Total Monthly Income. The result will be a percentage, or your debt-to-income ratio.
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Advantages to a Low Debt to Income Ratio
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- Appeals to new creditors.
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Disadvantages to having a High Debt to Income Ratio
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- Little money for savings.
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- Increases chances for financial problems.
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Your debt to income ratio is over the recommended percentage. If you do not reduce your debts, increase your income, or both, you are likely to fall deeper into debt or experience financial difficulties. Your goal should be to pay down your debt so you can become more attractive to creditors and get the best available interest rates.
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