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Q: I’ve heard some friends talking about their debt-to-income ratios. What is this? And how do I know if mine is good?
A: Your debt to income ratio is the portion of your monthly income that goes to paying debts. So divide how much you are paying on all your debts each month by your monthly income. It usually is calculated using your monthly gross income, which is your income before taxes are taken out.
If you multiply your result by 100, you can express your debt-to-income ratio as a fraction.
Many experts say a good debt-to-income ratio is around 36% or below. If you aren’t familiar with debt-to-income ratios, this means that no more than 36% of your gross monthly income should go to debt payments.
(Personally, I think a 36% dent-to-income ratio is high. If you do too, then don’t miss my final thought at the end of this article.)
If you are too much over 36%, you may be struggling to support your family, and may have some difficulty qualifying for a home loan. Even if your current debt is under 36%, if your mortgage payment would put you over the limit, all but subprime lenders will be a little wary to grant you a home loan.
Lenders also look at the amount of your gross income that is (or would be, in the case of a mortgage application) going to your mortgage payment. If this is over 28%, they may rethink approving you for a loan.
If your debt payments are under 36% of your gross income and your mortgage payment is under 28%, you are considered to be doing pretty well.
Pay down your credit card and car loan balances with timely payments so that your credit score starts to rise, and not only will you become financially secure, but creditors will be knocking on your door—not because you owe them, but because they want to lend to you.
One final though:
If you want to set an ambitious goal, see if you can reduce your debt to income ration to 20% or below over the next twelve months. Yes, that may mean cutting back on a lot of luxuries. But the money saved on interest charges after that point will more than pay you back over the long run.