Your debt-to-income ratio is an important financial measure that tells the percentage of your monthly income that goes toward debt payments. In addition to your credit score, lenders use the debt-to-income ratio to approve your loan applications. Many lenders use your debt-to-income ratio to decide whether you can afford to take on mrore debt. Thankfully, unlike your credit score, you can calculate and easily manage your own debt-to-income ratio without much trouble and guesswork.
Calculating Your Debt-to-Income Ratio
Your debt-to-income is calculated by dividing your total monthly debt payments by your total monthly debt payments. When you’re calculating your income, you can include income from your job as well as alimony and child support. For your debt payments, include your mortgage, car and student loan payments, and credit card minimum payments. Monthly bills aren’t included in your debt-to-income ratio.
Once you have those totals, divide your debt by your income than multiply the result by 100 to get a percentage. If your monthly income is $5,000 for example and your debt payments are $2,000, for example, your debt-to-income ratio would be 40%.
What’s the Best Debt-to-Income Ratio?
The lower your debt-to-income ratio, the better because it indicates you’re spending less of your income on debt. If your debt-to-income ratio is above 36%, it indicates that you have too much debt. You may have a hard time getting approved for loans with a high debt-to-income ratio because you’re paying a lot of your income in debt. It’s for the best – taking on additional debt may put too much strain on your budget.
How to Improve Your Debt-to-Income Ratio
If you need to lower your debt-to-income ratio so you can qualify for a loan or simply for healthier finances, there are generally two ways to do it.
First, you can increase your income. You might be able to do this by getting a raise, taking a higher paying job, taking on over time, or generating income from a side business. Having a higher monthly income not only lowers your debt-to-income ratio, but can also make it easier to save money, pay off debt, and save for retirement.
The second way to lower your debt-to-income ratio is to reduce your debt. Aggressively paying off credit card, student loan, and auto loan debt will lower your monthly debt payments. Paying off debt will lessen the strain on your finances, allow you to save money on interest, and even help boost your credit score. Paying off debt ahead of a mortgage or auto loan application will make it easier to get approved.
It’s a good idea to calculate your debt-to-income ratio once or twice a year to get an idea of where you stand. Even if you’re not getting ready to apply for a major loan, knowing how much you’re spending on debt will keep you aware of your finances and signal when you need to make changes.