Many lenders, especially mortgage and auto lenders, use your debt-to-income ratio to figure out the loan amount you can afford based on your current income and the amount you’re already spending on debt. For example, a mortgage lender will use your debt-to-income ratio to figure out the mortgage payment you can handle after all of your other monthly debts are paid. You can easily calculate your debt-to-income ratio to figure out the percentage of your income that goes toward paying down your debts each month. The first step in calculating your debt-to-income ratio is determining how much you spend each month on debt. To start, add up the total amount of your monthly debt payments, including the following:
Mortgage or rentMinimum credit card paymentsCar loanStudent loansAlimony/child support paymentsOther loans or lines of credit
Example:
Let’s assume Sam has the following debt expenses:
Mortgage = $950Minimum credit card payments = $235Car loan = $355
So, $950 + $235 + $355 = $1,540 total monthly debt payments You don’t need to include payments you make for car insurance, utilities, health insurance, groceries and other monthly expenses that don’t involve financing. Generally, if it doesn’t show on your credit report, it’s not factored into your debt-to-income ratio by lenders. Start by totaling your monthly income. Add up the amount you receive each month from:
Gross income from a W-2 job or self-employment Bonuses or overtime Alimony/child support Other income from various sources
Example
Remember, Sam spends $1,540 each month on debt payments. Each month, they receive income as follows:
Monthly gross income = $3,500 Child support = $500
Sam’s total monthly income = $3,500 + $500 = $4,000. Note: Multiply a weekly income by 4, and bi-monthly income by 2, to calculate your total monthly income. If you know your annual salary, divide by 12 to get to your monthly income.
Example
In our example, Sam’s monthly debt payments total $1,540 and his monthly income totals $4,000. So, divide $1,540 by $4,000 and then multiply by 100: $1,540 / $4,000 = 0.385 X 100 = 38.5%Sam has a debt-to-income ratio of 38.5%.
36% or less is the healthiest debt load for the majority of people. If your debt-to-income ratio falls within this range, avoid incurring more debt to maintain a good ratio. You may have trouble getting approved for a mortgage with a ratio above this amount. 37% to 42% isn’t a bad ratio to have, but it could be better. If your ratio falls in this range, you should start reducing your debts. 43% to 49% is a ratio that indicates likely financial trouble. You should start aggressively paying your debts to prevent an overloaded debt situation. 50% or more is an extremely dangerous ratio. This means that more than half of your income goes toward debt payments each month. You should be aggressively paying off your debts. Don’t hesitate to seek professional help.
Example
In our example, Sam has a debt-to-income ratio of 38.5%. While this isn’t a bad ratio, it could become worse if Sam were to increase his monthly debt payments without increasing his income.
