So, debt-to-income ratio is a metric that lenders use to measure a person’s ability to manage their monthly payments and repay their debts.
And it’s important for you to know because your debt-to-income ratio is what you need to know to see if you are creditworthy or not!
So if you know your own debt to income ratio, you can see if this is the right time for you to apply for a home loan or do you need to pay down some more debt first, then apply.
Knowing your debt-to-income ratio will answer the question:
“Is my total debt burden too high?”
Typically your debt-to-income ratio should not be more than 36% of your gross annual income. If you are looking to get a home loan, you may be allowed to go as high as 43%.
So let’s calculate!
The Formula
Annual debt repayments divided by your gross annual income then multiply that decimal number by 100 to get the percentage.
The Process
First, add up all of your monthly debt repayment amounts and multiply this number by 12 so that you have the annual amount.
As an example if you spend $1,000 a month on debt repayment, you multiply this by 12 months and that equals $12,000 a year that you spend on debt repayment.
Alright? Second, divide this number into your gross annual income (which is your income before deductions) and let’s say that is $50,000.
Third, multiply that decimal number by 100 to get the percentage of your debt-to-income ratio.
So! By The Numbers: $12,000 divided into $50,000 equals .24 times 100 equals 24%!
In this scenario you are in a very good place to apply for any credit cards or loans; you are deemed creditworthy.
Your debt-to-income ratio is only 24% which is well below the “no more than” number of 36%.
So, what if your expenses are higher and your income is lower? Well, let’s see…
Let’s say your total monthly expenses are $1,321, so for a year, you pay $15,852 in expenses. However, your annual gross salary is only $35,000. Let’s do the numbers.
So $15,852 divided by $35,000 equals .45 times 100 equals a little over 45%.
In this scenario, your debt-to-income ratio is too high; at over 45%, it is above the recommended number of 36% and even above the recommended 43% to qualify for a home loan.
So, in order for you to be creditworthy, you would need to either bring your expenses down or increase your income.
So if your debt-to-income (DTI) ratio is a low number, it tells a lender that you know how to balance your income and your expenses.
But if your DTI ratio is a high number, it can also tell them, and you, that you have too much debt for your annual or monthly income.
Now I am not an advocate for debt, but I do understand that it is necessary in some cases, for home buying, for instance. So if you are in the market and need to know where you stand, run the numbers and calculate your own DTI!
By The Numbers:
Monthly debt repayment amounts:
Multiply this number by 12:
Equals Annual amount:
Divide by your annual income before deductions:
Multiply that decimal number by 100:
Your debt-to-income ratio:
And if you want to keep this for reference, here is a downloadable pdf format, enjoy!