While planning to take any kind of loan for any purpose ( may be for-a new home, a new car etc.), one must keep in mind his /her true financial condition at that time and should act accordingly. Before applying for any kind of credit, a man or woman-no matter if he/she is into service or business, should first consider and calculate the highest loan amount the person is capable to repay in time-i.e., estimation of the capacity to pay off a loan is essential considering all other areas he/she simultaneously needs to spend money on.
Debt to income ratio (DTI) is an easy yet useful way of determining the net percentage of your total income per month that is available for making repayment of your pending debts.....
This ratio is of great importance to the creditors to judge your creditworthiness and your true financial capacity of repaying loans.Debt-To-Income ratio often plays a vital role when you want to go for a home purchase.
Calculation of debt income ratio is very easy.
There are two ways by which you can calculate this ratio: First one is called the Front-end ratio and second one is Back-end ratio.
Debt to Income ratio = Total monthly debt / Total gross monthly income
Front End Ratio = Monthly housing / Monthly income
There are another easier way to calculate your accurate Debt Income ratio. This calculation process includes all your pending debts like credit cards payments, mortgage, car loans, insurance premium, etc. and them divides this total monthly debt amount with your monthly gross income:
Back End Ratio = (Monthly debt amount / Gross monthly income) * 100
To calculate total debt amount for a particular month, you MUST NOT include monthly expenses on entertainment, grocery, food and other utilities.
Items to be considered for determining Total Monthly Debt :
• Monthly Mortgage payments or Rent Monthly Home Equity Line of Credit or Loan
• Monthly Car Payment
• Monthly Credit Cards payments
• Monthly Student Loan payments
• Monthly Child Support payments
• Other Monthly Loan amount
Items included in Total Monthly Gross Income :
1. Monthly Net (take-home) Salary
2. Annual Bonus and Overtime, divided by 12
3. Other Annual Income, divided by 12
A debt to income ratio equal to or below 28% speaks for a healthy and reliable financial condition. If the ratio stays between 28% and 36% for any person, then at this point he may be considered as financially fit, but at the same time he or she needs to keep a check on the amount of debt. Any value of the ratio above 36% raises an alarm of unstable, trembling financial condition for that person. It clearly expresses the person’s poor loan repayment capacity.
How to Improve your Debt Income ratio ?
• Figure out areas where you can cut some expenses: Chalk out your monthly budget at the month’s starting as soon as you get the income in your hand-make it a priority task to get a clear picture of your expense and pending debt situation.Once you have planned your budget for the month, sit down and figure out all those fields where u can bring about some reduction in your monthly expenses. Act accordingly, strictly follow your own-made financial expense plan, cut down on your expenses in those areas and put the money that you have saved to pay off the debt with highest interest rate like credit cards.
• Visit an advisor:
If your ratio is still not improving then don’t hesitate is seeing an expert financial advisor, like- a debt management professional, monthly budget and debt planning counselor etc. Just have some good financial counseling that will help you manage your debts in a smarter and efficient way, save you from ending up becoming debt-stricken and show you the way to a debt-free life in turn.
• Set yourself free from credit card debts:
Experts say try and start doubling your credit cards payments so that you start improving your debt to income ratio. If credit cards are not your problems then pay for any other debts as long as there are no prepayment penalties.
• Fund for emergency purpose:
Try and build an emergency monetary resource , so that you can come out of some kind of financial problems in future or have a nice vacation without falling back in credit cards debt.