17 Aug What Is Your Debt To Income Ratio?
Knowing your debt to income ratio, could help you make sounder financial decisions in the future. Your debt to income ratio is used by companies who are considering lending you money to determine if you are carrying too much debt in relation to your income. You can figure out your debt to income ratio rather easily on a monthly basis or a yearly basis.
I like to do both. I like to know what my monthly debt to income ratio is so that I stop myself from impulse purchases. Everytime that I am tempted to purchase something, I have that nagging little voice saying to myself, you need to lower your debt to income ratio, not increase it.
Likewise, knowing your debt to income ratio for the year will allow you to decide longer term strategies for dealing with your debt, and hopefully, eliminating it. So, let’s get into it. If you have a spreadsheet program, great. If not, please get some paper, a ruler and a pencil. The best way to do this is to graph it out.
I like to start with gross monthly income from all sources. Start with annual income and divide it by 12 to get an average monthly income. Make sure you add all income from bonuses, raises, etc. This will give a more accurate picture of your finances. Let’s say that the yearly gross income for the household is $60K. Then your monthly income is $5,000. Now, we go to the bills.
I like to make separate columns for the creditors (car payments, credit cards, store cards, medical bills, etc.) include the creditor’s name, total debt owed and monthly payment (If you want to go a little further, you can break down the principal and interest, but it is not really necessary for this exercise). Also, I don’t want you to add your mortgage, taxes, insurance and normal living expenses like utilities and cable here. We will add them later. Knowing your monthly payments is really the first step on the road to recovery. It is also really important to use accurate numbers on your debts, as a slight variation can make an incredible difference.
Now, all you need to do is to divide the monthly expenses by the monthly income. This number is your debt to income ratio. Please note that you will need to move the decimal point two places to the right to adjust accordingly. Use the graph below to determine your debt to income ratio.
0% to 10% – Great, stop reading, you are wasting your time.
10% to 15% – Good, but you need to keep your eye on things.
15% to 20% – Still good, but warning signs are going up.
20% to 30% – You need to either begin lowering expenses or creating more income.
Over 30% – You need help with your debt. You may be heading for bankruptcy.
Next, create a second graph for your monthly mortgage, taxes, insurance and other fixed costs. This second graph will not be factored into your debt to income ratio but will further add to your understanding of your finances. Once you have a grasp on how much cash is coming in and how much cash you have going out the door, you will begin to understand how much money you have for food, entertainment and most importantly, debt reduction.
Carmen Dellutri, Esq.
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