Calculating your debt-to-income ratio â Its role as a financial litmus test
Article by Jeff Wilson
Two major components of tracking your financial health are by giving a glance at your credit score and at your debt-to-income ratio, popularly known as the Debt ratio. It can be broken down into your income and debt levels and all of us don’t want out debt payments to be more than the income that we make in a month. But even though you make more money that your total debt obligations, how do you know that it’s well enough to secure a loan with a favorable interest rate? That’s where the role of the debt-to-income ratio can come in handy. This prompt calculation can immediately tell you where you stand financially and you can even get an approximate idea of the interest rate that you may be subject to on a loan.
What is the DTI ratio and how is it calculated?
It is nothing but the ratio of the total income that goes towards making your debt obligations in a month. A lot of lenders, especially auto loan and mortgage loan lenders use your Debt ratio to figure out how much portion of your monthly income goes towards paying the total amount of debt that you owe in a month. By checking your ratio, your mortgage lender will get an estimate of the amount of loan that you can afford according to your present financial worth. It is not that lenders can only calculate your DTI ratio; you can also do the same. If you’re wondering how, here’s help for you. Read on to know the steps in which you can compute your DTI ratio.
Add up your total monthly debt: Remember that your ratio is the total debt payments divided by the monthly income that you make in a month. Therefore, the first step that you must take is to add up the monthly expenses which are usually your mortgage payments, rent payments, student loan payments, car loan installments and all the other loans. Don’t forget to include a single loan as this may lead to errors in your calculation.Add your monthly income: The next step that you need to take is to add your monthly income. Start with the gross income, bonus and overtimes that you get, the alimony or child supports payments and all other income so that you can get the accurate DTI ratio after dividing.Calculate your DTI ratio: Once you finish calculating your total monthly income and what you spend in a month, you have to calculate your DTI ratio. In order to do so, you just have to divide the monthly debt payments by the monthly income. If you want to get a percentage of the Debt ratio, you should multiply the result by 100.What does your Debt ratio mean?
If the result is 36%, this is perhaps the healthiest debt load for most people and you should keep on paying the monthly debt obligations in order to maintain this ratio. 37%-43% isn’t a bad place too but 43%-49% is considered to be a bad signal and this may suggest that you’re going through financial trouble. 50% and more is a dangerous ratio and you must be aggressively repaying your debts to reduce it.
So, when you’ve finished calculating your ratio, you can be sure about the interest rate that your lender may offer you. Manage your personal finances in order to maintain a impressive ratio that can impress the lenders.
About the Author
This article is contributed by Jeff Wilson, who is a financial writer with quicklyprofit.com. He writes on various financial topics like budgeting, money management, debt consolidation, bankruptcy etc.
