Understanding Debt-to-Income Ratio
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- By Stacey Bumpus
- May 19, 2009
Wrapping your mind around debt-to-income ratio is as simple as applying a simple mathematical formula to your gross monthly fixed expenses. You never knew it was that simple, did you? To show you just how simple it is, let’s take a closer look at what debt-to-income ratio is and how to calculate it.
What is Debt-to-Income Ratio and Why Calculate It?
When managing finances, it’s important to get a grip on just how much you’re bring in vs. spending. By tightening up on spending, you can make sure to reduce frivolous debts and avoid adding on more.
But before you reach this stage, it’s a good idea to find out where you’ve gone wrong so that you can make necessary improvements. A great way to get this done is by calculating your debt-to-income ratio. This ratio is a configuration of how much you bring in versus how much you spend in fixed payments each month. Use a loan calculator to break down your monthly payments if needed. Once the ratio is calculated, you can determine whether you’re managing your finances correctly.
Calculating Your Debt-to-Income Ratio
The first step in making this calculation is adding up your monthly fixed expenses, including house payments or rental leases, revolving credit balances, car payments, alimony, child support, etc. Some items that should be excluded from the list include items that can be paid off in a couple of months or less, including utilities or grocery bills.
Next, you want to jot down your gross monthly income (the amount you earn before taxes and benefits). Then divide the monthly fixed expenses into the gross monthly income for your ratio.
How Your Debt-to-Income Ratio Affects Your Credit
Did you know that your debt-to-income ratio being too high can negatively affect your credit? If after calculating the ratio, you find that yours is higher than 36%, your debt is considered too high – as a result, your credit score can lower. And of course, the result of a lowered credit score is higher interest rates and turned-down applications for credit.
Taking the time to understand your debt-to-income ratio and how it affects your life – and credit score – can help you make the best decisions on managing your monthly fixed expenses in relation to your gross monthly income.