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 .
