Debt to Income Ratio – Knowing Yours Could Make a Difference

Your debt to income ratio is the relationship of your non-mortgage related debt to your gross monthly income. It is found by dividing non-mortgage related debts by the gross monthly income. The result is expressed as a percentage. When lenders are determining whether or not to extend credit, one of the key elements considered is your debt to income ratio.

An acceptable debt to income ratio, by most lenders’ standards, would be 35% or less. The lower the ratio, the less debt the borrower is carrying in relation to their income, and thus, the better equipped they are to take on more debt without causing a hardship.

To calculate your own debt to income ratio, first add up your monthly credit expenses. These would be payments toward student loans, credit cards, car payments, bank loans and so on. Do not include mortgage or rental payments, alimony or child support payments in this calculation. These items are reported separately on a credit application.

Next, determine your gross monthly income. Gross income is your income before any deductions are made.

To calculate your debt to income ratio then, divide your monthly debt by your monthly gross income. The result is your debt to income ratio. Below are some examples to better illustrate the calculations and how different ratios are ranked by lenders.

Debt to Income Ratio Examples

Example 1: Anglia A pays $250 on a car loan each month, plus $300 for student loans and $75 towards credit cards. Her monthly credit debts are $625.

Her gross income is $775 every two weeks. Since she is paid every two weeks, she must first determine her yearly income. Take the 26 paydays she receives annually and multiply that by her gross pay for each pay period (26 X $775 = $20,0150 annual gross income). To calculate her monthly income then, divide her annual income by 12 months ($20,150 divided by 12 = $1,679 monthly gross income).

To determine her debt to income ratio, she would divide her monthly debt ($625) by her monthly gross income ($1,679) which gives her a debt to income ratio of 37.2%. This is above what most lenders consider acceptable for the high end of debt to income ratio.

If your debt to income ratio is above 30%, be prepared to provide excellent documentation of your income and debts when applying for credit.

Example 2: Billy B has a gross monthly income of $3,500 a month. His monthly debts are $450 in car payments, $100 in credit card payments, and $70 for a personal loan. His total monthly credit debts are $620. By dividing his debt of $620 by his income of $3,500, he sees that his debt to income ratio is 17.7%.

Billy’s debt to income ratio is in an acceptable range and right around the average for most people.

The Credit Secrets Bible contains more information on debt to income ratio, as well as numerous guidelines on raising your credit scores fast.