Debt-to-income ratio, also known as: High School Math Class, Revisited
People often want more house than they can afford, more car than they can afford, more things than they can afford. Perhaps it’s just human nature to stretch your budget. In our consumer-oriented society, there are a lot of forces telling you to buy a bigger, or faster, or better than what you need.
As tempting as it all is, you must avoid this mindset. Overspending creates financial problems that can be a source of stress and have negative effects on your marriage, family relationships and, of course, your financial health.
Your community banker will also help you dial down your instincts to buy things beyond your means. Your banker will explain debt-to-income ratio. Yes, for a brief moment you will feel like you are back in high school math class. It’s okay, understanding debt-to-income ratio is important.
So, what is a debt-to-income ratio?
Well, it’s pretty much exactly as it sounds: all your debts compared to your total income. Or more specifically, your total monthly debts (using minimum payments) divided by your total gross monthly income.
So if you pay, let’s say, $300 a month for all your loans, credit card bills, lease payments and housing expense, and you bring in $1,000 total a month (before taxes), your debt-to-income ratio would be 30% ($300/$1,000). This is a fairly healthy and normal ratio which allows for other expenses and the ability to invest.
Okay, so how do you rank a good to a bad ratio percentage?
Here’s a guide:
- 36% or less: a healthy debt load to carry for most people.
- 37%-42%: Not bad, but start paring debt now before real trouble.
- 43%-49%: Financial difficulties are probably imminent.
- 50% or more: Get professional help to aggressively reduce debt.
Budgeting for the right debt-to-income ratio is the key to having a happy, secure financial life. Prepare a household budget and stick to what you can conveniently afford, despite the temptation to buy a bigger home, car or spend more money on other amenities.
Examine what you are now paying for housing and other expenses to get an idea of what you can handle going forward. Calculate your own debt-to-income ratio and start to live a financially happy and healthy life!
