Debt to Income Ratio

Debt to income ratio

Thinking of purchasing a big-ticket item soon? Maybe a new car, that fancy refrigerator you've had your eye on, or a home? Well, even if you've paid your bills on time and think you can swing the payments, you should also consider your debt-to-income ratio.

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Debt-to-income Ratio
This ratio is calculated by comparing your income to the total amount of debt you have. The exercise can be revealing, especially when you calculate this ratio regularly. However, waiting for a lender to do it can generate less-than-appealing results—if your debt-to-income ratio is too high, you will likely get a higher interest rate and you could even be turned down for the loan.

The ratio appears as a percentage—the percentage that the debt is to the income. A 30% ratio means you use 30% of your total gross monthly income (before taxes) to pay your monthly debts. The lower the ratio, the better your ability to qualify for loans.

Calculating Your Ratio
There are many calculators available on the Internet to help you calculate your debt-to-income ratio. To get a quick sense of your debt load, you simply divide your total monthly minimum debt payments (not including mortgage or rent payments) by your monthly gross income.

Your monthly payments include: car payments, installment loans on furniture or appliances, bank or student loans, minimum credit

card payments and medical care payments.
Your income includes: your paycheck, any alimony or child support payments, bonuses, commissions and tips.

An Acceptable Ratio
These guidelines differ depending on the lender with which you're dealing. In general:

35% or less: This is an average debt load for most people. If you keep your ratio around 15%, you're in great shape.
36%-42%: You need to control your credit spending and work on a plan to start retiring some of your debt.
43%-49%: You could soon face financial difficulties unless you start lowering your debt now.
50% or more: You may need to seek professional help to aggressively reduce your debt load. The National Foundation for Credit Counseling (www.nfcc.org) offers free assistance to people who need to get a handle on their finances.

Remember, if your debt-to-income ratio looks good and you're ready for that big-ticket purchase, you should also check your credit report for any possible inaccuracies that could impact your credit rating.