Monitoring your debt and maintaining it at a manageable level are important steps in ensuring your financial security. Take the time to learn the proportion of your debt to your income. Your debt load ratio, also known as debt-to-income ratio, is a metric that lets you see whether your debt load is getting lighter or heavier. Using this tool regularly can help improve your financial health.
Debt-to-income ratio is a financial analysis tool designed to measure the ratio of your total debts against your total income. It shows you what percentage of your monthly gross income goes toward paying debts. Comparing past and present figures lets you gauge whether the portion of income you are spending on monthly debt payments is getting bigger or smaller. Also, comparing the ratio against standards set by lending institutions allows you to gauge if your debts are at a maximum or minimum level.
Dividing your total monthly debt by gross monthly income and multiplying the resulting figure by 100 gives you this ratio in percentage terms. Total debt refers to all monthly payments you make to service your debt. It includes your monthly credit card payments, car loans, payday loans, investment loans, rent or mortgage payments, interest, property taxes and insurance and homeowner association fees. Gross monthly income includes all earnings you make within the month before paying income taxes. Dividing your gross annual income by 12 yields your total monthly income.
As an example, let’s assume that your financial records show that your monthly debt payments consist of $100 on credit cards, $300 on car loans and $1,000 in rent or mortgage. Adding your monthly debt payments will result in a total monthly bill of $1,400. If you earned $84,000 during the past year, your monthly gross income would be $80,000 divided by 12 months for a total of $7,000 a month. Dividing your total monthly debt payments of $1,400 by your gross monthly income of $7,000 will result to a debt-to-income ratio of 0.20. Multiplying 0.20 by 100 will convert the figure to 20 percent.
Although everyone's financial situation and needs are different, there are some general rules to follow when it comes to your debt load ratio. According to the Practical Money Skills website, a debt-to-income ratio of 10 percent or less is "outstanding." You ratio is good if it falls between 10 percent to 20 percent, but if it rises above 20% you should take steps to get it down. Banks and other lending institutions typically set debt-to-income ratio standards as criteria for loan applications. Banks would consider it too risky to lend you funds if your ratio is higher than 20 percent.
Video of the Day
- keyboard with green button of risk image by air from Fotolia.com