Is it possible that your debt is affecting your credit? This is how you can tell if your debt is out of proportion to your income.
One of the foundations of good financial health is keeping your debt at a manageable level. But how do you know if your debt is getting out of control? Fortunately, there is a way to figure out if you have too much obligation without waiting until the time you can’t make your monthly payments or your credit score begins to drop.
What is the debt-to-income ratio?
Your debt-to-income (DTI) is a ratio that compares your monthly expense debts to your monthly gross income. To calculate your debt-to-income percentage, add up all the payments you spend on your debt during an average month. That includes your monthly credit card payments, car loans, other obligations. (for example, payday loans or investment loans), and housing expenses, whether rent or mortgage principal payments, plus interest: property taxes and insurance (PITI), and any homeowners association fees.
Then, to get your ratio, divide your monthly debt payments by your gross monthly income, your income before taxes. (Often, your balance is multiplied by 100 to present as a percentage.)
For example, if you pay $400 in credit cards, $200 in car loans, and $1,400 in rent, your monthly debt commitment is $2,000. If you earn $60,000 a year, your monthly gross income is $60,000 divided by 12 months, or $5,000. Your debt-to-income ratio is $2,000 divided by $5,000, which works out to 0.4, or 40 percent.
Sources of financial income
Financial income comes from cash and a set of assets with certain degrees of liquidity. Among the sources of this income are the following:
- Interest on loans granted by the company.
- Inversions in actions.
- Bond holding.
- Fixed Income Securities.
- Discounts on purchases for prompt payment.
- Currency holding.
Ultimately, these revenues are resources that the company receives due to its financial operations. Therefore, income results from various economic activities that the company carries out over a given period.
Why is my debt-to-income ratio important?
Banks and other lenders study their customers’ debt before they run into financial difficulties and use this information to set loan amounts. While the desired maximum DTI varies among lenders, it’s often closer to 36 percent.
How to lower your debt-to-income ratio
If your debt-to-income ratio is close to or greater than 36 percent, you may want to take some steps to lower it. To do so, you can:
- Increase the amount you pay monthly towards your debt. Making extra payments can help you reduce your total debt faster.
- Avoid taking on more debt. Consider reducing the amount you charge on your credit cards and postpone additional loan applications.
- Postpone large purchases to use less credit. More time to save means you can make a larger down payment. You’ll have less to finance with distinction on an investment, which can help keep your debt-to-income ratio low.
- Recalculate your debt-to-income ratio monthly to see if you’re making progress. Watching your DIT go down can help motivate you to keep your debt under control.
Keeping your debt-to-income ratio low helps ensure you can pay your debt and gives you the peace of mind that comes from managing your finances responsibly. It also enables you to be more likely to qualify for credit for the things you want in the future.