What to Know About Your Debt to Income Ratio

Debt to income ratio is a widely talked about concept in personal finance, and for good reason. It’s an effective barometer to understand how your personal debts relate to your overall financial health. When you’ve calculated your debt to income ratio, you’ll be able to plan and budget more effectively.

Essentially, your debt to income ratio equals the amount of debt you have versus the amount of net income you have. To calculate your debt to income ratio, add together your monthly expenses. This will include your mortgage or rent, your loan payments, credit card payments, auto loans, and other personal debts. Then divide these financial commitments by the amount of your gross annual income. The percentage amount will be your debt to income ratio.

In general, you should be making much more than your total in debts, otherwise you’ll never be able to tread above water and pay off your debts. Lenders and creditors will often take a look at your debt to income ratio and use this percentage as a way of determining if you’re capable of handling another debt on top of your existing ratio. For example, if your debt ratio is greater than 50% of your income ratio, then creditors can assume you’ll have difficulty making payments in a timely, consistent manner because your overall debt amount is so significant.

If your debt to income ratio is higher than 50%, you may run into trouble getting approvals on a personal loan, auto loan, or other loan application. While it’s not the only say in a lender’s decision to approve a loan, it can affect the process. Once you know your debt to income ratio, you can plan accordingly how to manage your debts in a more aggressive way to lessen that ratio over time.

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