Debt to income ratio is a simple way of showing what percentage of your total income is available for paying off your debts. It is often abbreviated as DTI. Debt-To-Income ratio often plays a big role when you are going for a home purchase. This ratio is a one of the most vital things that lender considers in determining your power to pay off a loan.
If some one has a debt to income ratio equal to or below 28% then he or she may be considered to be financially healthy. If its between 28% and 36% then at this point he is financially healthy but at the same time he or she needs to keep a check on his debt. And anything above 36% then the person he or she financially unhealthy, he needs to visit a doctor fast!
Calculating debt income ratio is very easy and can be done on your kitchen table. There are two ways you can calculate this ratio depending on the debts you are including in the calculations.
One is by including only and all your housing expenses which include home insurance, mortgage, taxes and other home related expenses. Once you have calculated total housing expenses divide it with your gross monthly income.
For example: If you earn $2500 per month and have a mortgage expense of $500, taxes of $250 and insurance premium of $200 then your debt income ratio is 38%
Another way to calculate Debt Income ratio is by including all your debts like mortgage, car loans, insurance premium, credit cards payments etc. and them divide it with your monthly gross income.
For example: If you earn $2500 per month and have a car expense of $250, taxes of $250, insurance premium $200, mortgage payments of $500 and credit cards payment of $100 then your debt income ratio is 52%. Which also means that you are financially very unhealthy and need to see some financial doctor (Get some financial counseling) immediately.
And make sure that when you are calculating your total monthly debt you do not include monthly expenses on entertainment, grocery, food and other utilities.
Now many people may ask
why Monthly Gross Income instead of Net Income, ultimately that’s what I take home. But one of the prime reasons lenders consider gross Income and not net income is because at the end of the year when you file taxes you may get some deductions and returns so they believe that if Debt Income Ratio is calculated with gross income it will give them more realistic results.
But lenders do consider this for business owners as they calculate there debt to income ratio on adjusted gross income.
Items included in Total Monthly Debt
- Monthly Mortgage payments or Rent
- Monthly Home Equity Line of Credit or Loan
- Monthly Car Payment
- Monthly Credit Cards payments
- Monthly Student Loan payments
- Monthly Child Support payments
- Other Monthly Loan amount
Items included in Total Monthly Gross Income
- Monthly Net (take-home) Salary
- Annual Bonus and Overtime, divided by 12
- Other Annual Income, divided by 12
How to Improve Debt Income
- Figure out areas where you can cut some expenses: Once you have done your budget and worked on sot cutting, put the money that you have saved after that to pay off the debt with highest interest rate like credit cards.
- Get out of credit card debts: Experts say try and start doubling your credit cards payments so that you start improving your debt to income ratio. If credit cards are not your problems then pay for any other debts as long as there are no prepayment penalties.
- Emergency Fund: Slowly but steadily try and build an emergency fund so that you can come out of some kind of financial problems in future or have a nice vacation without falling back in credit cards debt.
- Go to a Financial Doctor: If your ratio is still not improving then don’t hesitate is seeing a financial doctor, I mean have some kind of good financial counseling that will help you manage your debts in a better way.
