How to calculate debt to income ratio Overview
Debt to income ratio is a handy tool that helps you know how much of your monthly expenses are going towards paying off debts and how much money can be saved. It also tells whether you have enough money left over at the end of each month to pay other bills like rent, food, etc.
If not, then what will happen? Will you still get paid on time? Or will you lose your home/car/other valuable assets? So calculating the Debt to Income Ratio is helpful as it gives us all these answers.
Step-by-step guide on calculating debt to income ratio
- Calculating the total amount of debt owed :
We first need to find out our current balance of credit card payments, auto loan payments, student loans, mortgage, personal loans, car notes, etc. This includes everything except for regular household bills such as electricity bills, water bill, phone bill, cable TV bill, internet bill, gas bill, insurance premiums, property tax, etc. We should only count those things which are directly related to buying new products or services.
For example, I don’t consider my grocery bill as part of my debt when I buy groceries because I am using cash to purchase them. But when I use credit cards to make purchases, I must add up all the charges made during one billing cycle and divide it by 12 to figure out how many months’ worth of interest has been added onto my existing balances. The result would give me the number of months until I’ll reach zero balance. For instance, let’s say I owe $1,000 on three different credit cards. My average daily spending per card is $100. That means I’m adding 3x$100$300 in interest per year. Therefore, it takes me 9 years before I’d reach 0% APR.
- Divide by gross income
Once we’ve calculated the total amount of debt, now comes the next step – dividing it by Gross Monthly Income. To do so, multiply the total amount of debt by 100 and divide it by Gross Monthly Income. Let’s take another example where I owe $1000 on one credit card. And my Gross Monthly Income is $4,500. Now, I will take $1000/$4500 and get 0.22. Then multiply this figure by 100 to get the percentage. This should give me 225%. The higher the debt to income, the more vulnerable you are to lenders and vice versa.
Tips on how to lower your debt to income ratio
If you want to reduce your debt to income ratio, here are a few ways to help you achieve that goal:
- Consider loan forgiveness
Many people who carry high amounts of debt often think they cannot afford to repay their loans. However, there may be programs available through federal government agencies that allow borrowers to wipe away certain types of debt. These programs vary depending upon the type of debt being forgiven.
- Pay off high-interest debts first.
When you’re looking at your budget, always prioritize your highest-rate debts first. Once you’ve cleared those accounts, move on to the ones with lower APRs. If you have a lot of low-APR debts leftover from last month, pay them off immediately. Otherwise, you might be tempted to put them aside for later. Don’t fall into this trap — paying off these smaller debts won’t save you money in the long run. Instead, concentrate on clearing your biggest debts first.
- Find a source of side income.
One great way to earn extra money while still keeping your current lifestyle intact is through side hustles like freelance writing, dog walking, tutoring, etc. You can also look into starting a small business. There are plenty of online resources available today that teach you everything you need to know about running a successful startup.
- Cut unnecessary expenses
The best thing you can do to improve your financial situation is to eliminate wasteful habits. Start by cutting back on nonessential items such as cable TV, gym memberships, eating out, coffee shops, newspapers, magazines, etc. Next, find ways to trim other costs, including transportation, entertainment, clothing, personal care products, home maintenance, insurance premiums, etc. Finally, learn to live within your means.
- Don’t carry too much debt.
The best thing you can do to improve your financial situation is to avoid carrying too much debt. When you borrow money, you incur interest costs and other expenses like insurance premiums, taxes, etc., which eat away at your savings. It makes sense then to keep your monthly obligations under control. You can accomplish this by keeping track of your outstanding bills and setting realistic goals for yourself.
- Get professional advice
There’s no substitute for good old-fashioned common sense. But when it comes to managing your finances, nothing beats expert guidance. A qualified or certified public accountant can provide valuable insight into what steps you need to take to reach your personal finance goals. They’ll also make sure you don’t miss out on tax deductions or opportunities to minimize your overall cost of living.
Debt to income ratios helps us understand how we spend our money.
By knowing how to calculate it, we can better manage our spending to achieve our financial goals. In addition, having a clear understanding of where our money is going will enable us to identify areas where we could cut down on expenditures.
This will ultimately lead to more savings and less stress!