The most important indicators of overall financial health are a good credit score and a solid debt to income ratio. While your debt-to-income ratio does not affect your credit score, it can help determine how comfortable you should be with your current debt amount, and help you decide on how much credit is right for you.
What is debt-to-income ratio?
When you apply for credit, lenders will look at your income and current debt load and then decide whether you can take on another payment.
In this calculation, “debt” includes everything you pay out, including rent, child support, loan payments, credit card payments, and other debts. Typically expenses like groceries, utilities, and taxes are not included in this calculation.
To calculate your debt-to-income ratio, add up your relevant monthly bills like your mortgage or rent, alimony or child support payments, all of your loans, your credit card minimum payments, and any other debts you have. Divide this total by your gross monthly income, which is your income before your taxes. The number you have leftover is your debt to income ratio, and it is in the form of a percentage. For example, if your total monthly debt payments are $800 and your monthly gross income is $2000, we would take the $800 divided by $2000. This would get 0.4, which as a percentage would be 40%. The lower you can get this percentage, the less risky you are to lenders.
Your debt-to-income ratio compares how much money you owe each month to how much money you earn. This percentage is important because lenders will evaluate your ability to repay new credits based on this number. There are two major ways to lower your debt-to-income ratio. The most logical way is to generate more income. The second way is a little bit simpler: Pay off a portion of your debt or lower your monthly bills. Either of these two methods of lowering your debt-to-income ratio will make you more appealing to lenders.
If the easiest way for you to lower your debt-to-income ratio is by reducing your debt, consider enrolling in our debt program which can help to reduce your debt and lower your monthly bills at the same time! A credit consultation with our team of debt experts only takes a few minutes and is completely free!