Your debt-to-income ratio is an incredibly valuable number. It will inevitably be brought up when applying for loans and credit, right alongside your credit score. Measuring your debt against your income gives it context, and the more you make, the more debt you can afford to take on. What, then, is a healthy debt-to-income ratio and what is manageable?
Your debt-to-income ratio, put simply, is the percentage of your income that goes toward paying your debt. To calculate your ratio, start by totaling your monthly debt. Your monthly debt includes what you spend each month on your mortgage or rent, your minimum credit card payments, car loan, student loans, alimony or child support and any other debt you have
Once you have your debt calculated, total your yearly income. This includes your gross income, bonuses or overtime, alimony and child support received plus any other income you may have. Divide this number by 12 to determine your monthly income.
Once you have your monthly income and the amount of money that goes toward your debt monthly, divide the debt payments by your monthly income and multiply by 100. The number you come up with, a percentage, is your debt-to-income ratio.
By most standards, a debt-to-income ratio of 36 percent or less is considered a healthy debt load for most people. From there, if your ratio falls within the 37 to 42 percent range, you should consider reducing your debt, but it is not yet an emergency. With a ratio of 43 percent to 49 percent, you might be in financial trouble and you should start paying your debts immediately to prevent an overloaded situation. Anything greater than 50 percent is a dangerous ratio. If you fall above 50 percent, you should be aggressively paying off your debts or seeking professional help.
Aside from helping you get more credit or loans, a healthy debt-to-income ratio also helps you avoid the gradual rising of debt, which is a common pitfall. Controlling your debt-to-income ratio means you’re making sound decisions and managing credit card use and impulse buys, all things that point to a healthy financial standing. Managing your debt-to-income ratio is crucial for everything from managing debt to knowing how much house you can buy with your income. When you have a healthy debt-to-income ratio you can put more money toward other budget priorities, such as savings.