Credit Basics

How To Calculate Your Debt-Income Ratio

In order to discover if you are in a financial crisis, you must know how much you spend each month to pay off debts and other financial commitments. This is your debt-to-income ratio. Your debt-to-income ratio is the percentage of your income you use to pay off your debts. Most financial experts believe that you should maintain your debt-to-income ratio at 36 percent of your gross income.

Banks and other lending institutions use your debt-to-income ratio to gauge your ability to repay debt. If you have a low ratio, you have a better chance of repaying your debt. If you have a high ratio, you are viewed as a credit risk, which could prevent you from finding affordable credit.

Time to Calculate

Calculating your ideal debt-to-income ratio is not hard – simply take your monthly gross income, for example say $1,600 a month, and multiply it by 36 percent: $1,600 x .36 = $576.

Your debt payments should not surpass $576 a month. This easy to understand method will give you a better understanding as to how much of your income should be spent on paying off your debt. It also lets you know if you are overburdened by debt.

Okay, now it’s your turn. Gather several of your recent pay stubs to figure out your average monthly gross income (your gross income is your salary before any deductions are subtracted). Now gather several of your recent credit card statements and figure out the average you are paying each month. Once you have that, you will need to collect your other monthly debts, such as rent or mortgage payments, car loans, personal loans or school loans. You can leave out your household expenses such as groceries.

Once you have assembled all of this information, take your average credit card amount and add that to the total number of your other monthly debts (rent, mortgage, loans, etc.) Now divide that total number by your monthly gross income – as we did in the example above.

For your convenience, we have included our debt-income ratio calculator so you can simply enter your data to calculate your debt-to-income ratio.

Understanding your debt-to-income ratio

36% or less: This is the ideal amount of debt for most people to carry.

37%-42%: This is okay, but start cutting your spending now before you get into deeper debt.

43%-49%: Financial distress is right around the corner unless you act quickly to prevent it.

50% or more: You need professional assistance to severely reduce your debt.

Dealing with a High Ratio

If your debt-to-income ratio is too high, don’t panic. There are two obvious options, lower your monthly debts (cut back on the use of your credit cards) or increase your income. We know this is not as easy as it sounds, but to improve your money management skills you will have to sacrifice in some manner. The easiest is to stop the frequent use of your credit cards. Put them away.

If you're concerned about your credit management, we can help. Our first step would be to prepare a free budget & debt analysis for you. Take into account everything that you spend money on – coffee in the morning, filling up your gas tank, restaurant visits, shopping at the mall. You may surprise yourself at how much you can cut back to help alleviate your debt.

By sacrificing your Friday night visit to your favorite restaurant or by cutting back on the amount of coffee you drink each day, you can help yourself become debt free. Take responsibility of your finances -- discover your own spending habits and how to make smarter purchases, educate yourself and you will lower your debt-to-income ratio.

Contact Consolidated Credit Counseling Services at 1-800-320-9929 or click on the link for a free debt & budget analysis. Our professional, certified credit counselors are here to help you take the first step toward financial freedom.