How to Calculate Debt to Income Ratio
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Do you know how to calculate debt to income ratio?
You will usually need to know how to calculate debt to income ratio when you are applying for credit of any kind.
This is especially important if you are ready to buy your first home.
If you’re trying to organize your finances, save for a home, or reach other financial goals, debt to income ratio is important to know!
How to Calculate Debt to Income Ratio in 5 Easy Steps!
Add up all of your monthly income sources
It’s important to know your monthly income for several reasons, but you definitely need to know this in order to calculate your debt to income ratio.
Add up all sources of monthly income that you have each month. This is your paycheck, and can be any side hustles too!
Related: How to Budget for Beginners
List all of your monthly financial obligations
You will need to know your monthly payments for all debts, rent or mortgage payments, and any other large payment you make each month.
Monthly obligations like utilities, gas, and other simple necessities are usually not considered in this ratio (by banks and creditors).
Financial obligations considered in the debt to income ratio usually include:
- Student Loan Payments
- Rent or Mortgage
- Car Payments
- Child Support or Alimony Payments
- Credit Card Minimum Payments
Divide the total debt by your income
You will use your gross monthly income, which is your monthly income before taxes.
The number you get will be a percentage.
This is your debt to income ratio!
Here’s an example.
Sally brings home a gross monthly income of $5000.
- Rent: $1200
- Car Payment: $350
- Student Loan Payment: $400
- Credit Card Minimum Payment: $120
- Total Monthly Debt Payments: $2070
Monthly Debt Payments ($2070) divided by Monthly Gross Income ($5000) = 0.414 or 41.4%
Sally’s monthly debt obligations are nearing half of her monthly gross income! Taking on more debt would definitely be stressful!
Analyze your debt to income ratio
The lower the percentage number, the less risky you are considered to lenders.
If you’re debt to income ratio is high, you need to pay down debt or reduce your monthly payments.
Related: How to Pay Off Debt Fast
Consider the Reasons you are Applying for More Debt
You followed these steps, and found out that your debt to income ratio is high.
It’s time to ask yourself why you are applying for more debt in the first place?
If you’re debt to income ratio is high, that means you have almost as much debt as you do income.
This probably means you are living paycheck to paycheck, even though you probably make a great income!
Don’t worry, you’re not alone! In fact, almost 80% of Americans live paycheck to paycheck.
We follow Dave Ramsey’s Baby Steps to get out of debt. He recommends never using debt of any kind, with the exception of a mortgage.
If you don’t have debt, you have…money! Consider getting serious about your budget and paying off debt.
When you are debt free, and apply for a mortgage, you won’t need to worry about your debt to income ratio at all!