Debt to Income Ratio

 Your debt-to-income ratio is simply comparing what you earn against what you spend, and using this to track your financial habits. This ratio is a great ways to determine if you have too much debt or if you are heading toward financial issues.  It is used to determine your credit worthiness.  Here is how you calculate your debt to income ratio.

Things You’ll Need:
calculator
Step 1 - To determine your debt to income ratio, we are going to use an equation that looks something like this: (TOTAL MONTHLY DEBT) divided by (TOTAL MONTHLY INCOME) = (YOUR DEBT TO INCOME RATIO)*(100) What this means is that we want to figure out the debt to income ratio as a percentage. So in this equation we divide your total monthly debt by your total monthly income to come up with your debt to income ratio.
Step 2 - On a piece of paper or in Microsoft Excel - make a column that shows all of your monthly debt obligations and the cost per month for each debt. Identifying where all of your money goes so that you can track it is the biggest step. If you make a monthly payment on anything, include it! Examples of things to include in this column are as follows: monthly credit card bills, monthly loan payments, mortgage payments, or home equity line payments monthly insurance payments monthly rent payments, monthly car and vehicle payments, monthly school loans, average utility costs per month, average grocery costs per month, average gas costs per month. Monthly revolving credit payments (furniture, appliance loans, etc.) Other monthly loan amounts Monthly child support payments, etc.

Step 3 - After you have identified all of your monthly debts and added up the total for each payment each month, we are going to add this into our equation from Step 1 in the "TOTAL MONTHLY DEBT" area of the equation. (TOTAL MONTHLY DEBT) divided by (TOTAL MONTHLY INCOME) = (YOUR DEBT TO INCOME RATIO)*(100) For Example - lets assume that I have done step 1 and 2 and my total monthly debt equals $2,500 for all of my monthly payments. My equation would look like this: ($2,500) divided by (TOTAL MONTHLY INCOME) = (YOUR DEBT TO INCOME RATIO)*(100)

Step 4 - Next we have to figure out our total monthly income. Make another column on your piece of paper or in Microsoft excel and write down all of the monthly income that you make. We are looking to calculate your total net income so that would be all take-home money after taxes, health insurance, etc, that you receive. If you work in sales and your income varies, figure out the monthly average for the past two years as a baseline. Examples of your monthly income would be as follows: monthly wages and any overtime, commissions or bonuses that are guaranteed, rental or income property payments, payments from loans you have lended out, monthly utility credits if applicable, alimony payments received.

Step 5 - Take all of your income and add it up. We are going to add this into our equation from Step 1 in the "TOTAL MONTHLY INCOME" area of the equation. (TOTAL MONTHLY DEBT) divided by (TOTAL MONTHLY INCOME) = YOUR DEBT TO INCOME RATIO For Example - lets assume that I have done step 1, 2, 3, and 4 and added up my total monthly income. Lets say that it equals $5,300 for all of my monthly payments received. My equation would look like this: ($2,500) divided by ($5,300) = (YOUR DEBT TO INCOME RATIO)*(100)

Step 6 - We need to divide the number we got for our total monthly debt by the number we got for our total monthly income. The equation would now look like this: $2,500/$5,300 = (0.472)*(100) Your equation will probably look different, and if you want to see how I got the 0.472 try my equation first. Use your calculator and divide 2,500 by 5,300. You should get a number equal to 0.472.

Step 7 - What does your Debt to Income Ratio number mean? The lower the number you have, the better. Your Debt to income ratio is used to score you on a financial risk table and affects loans you are eligible for, payment plans you are eligible for, and also helps to analyze how well you can afford to save or pay people back. If your ratio is higher than 0.36 or 36% - then you need to start reducing your debt because you are seen as a financial risk in the credit industry. Any score higher than 36 or 0.36 may cause an increase in the interest rate or the down payment on any loan you apply for. You are also spending more than you can comfortably afford and you do not have enough money to save for the long term of for emergencies. So now that you know this ratio, start playing with ideas to reduce your debt to help you decrease your debt to income ratio.

 

 

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