Debt To Income Ratio Can Help Determine If You Have Too Much Debt
You might consider that you have too much debt but there is a way to determine whether your debt is manageable that is measured by the debt-to-income (DTI) ratios. Avoiding debt can be tricky and can be inevitable depending on your financial situation that can easily get out of control.
Managing your finances is the first step in making sure you don’t get overwhelmed with debt before it’s too late. There are different forms of DTI ratios when combined will help give you a sense of your financial situation when it comes to debt.
The Front End DTI Ratio measure the ratio of your housing costs to your gross income with the total calculated representing the total housing costs based on combining fees, mortgage principal, taxes, interest, and insurance divided by gross income or (fees + mortgage principal + taxes +interest + insurance)/(gross income).
Income and housing costs can be considered on a monthly or annual basis, making sure you use the same time period in the numerator and denominator. The ideal target total for this ratio is 28 representing your housing costs is no more than 28% of your gross income.
The Back End DTI Ratio determines the ratio of your housing costs combined with all other debt payments including auto loans, credit card debt, student loan debt, and any other debt you’re still paying off. To determine the Back End DTI Ratio you’ll combine student loan payments, principal, credit card payments, interest, fees, insurance, taxes, and other payments divided by your gross income or (student loan payments + principal +credit card payments + interest + fees + insurance + taxes + other payments)/(gross income).
To calculate this figure, use the numerator from the Front End DTI Ratio and add all other payment amounts. The standard target total for the Back End DTI Ratio is less than or equal to 36 representing your total housing costs combined with other debt payments are less than 35% of your gross income.
The combination of the two ratios translates that your non-mortgage debt payments should be under 8% (28% to 36%) of your total gross income. These ratios are used by mortgage lenders when qualifying you for refinancing or a new mortgage as lenders are using these ratios as a determining factor as credit is tight.
Financial institutions like banks or private institutional leaders will use these ratios before extending credit and limiting the amount of credit they are willing to qualify for you. If your ratios are higher than expected, there are a couple of ways to improve your ratio that can help improve your financial situation.
Here are some methods of improving your ratios:
- Look for extra income that will help maximize your debt payments.
- Make a commitment to prevent taking on new debt.
- Consider downsizing your home or refinancing to lower housing costs.
Create a plan to pay off consumer debt.