Debt to income ratio is a personal finance measure, which is used to compare an individual’s debt payments to the income that he generates. The financial measure is a crucial concept in the lending industry because it gives these lenders an indication of how likely it is that the person who has borrowed will repay the loan owed.
There are essentially two types of debt to income ratios: front-end and back-end. Front-end ratio indicates the percentage of income generated that goes toward housing costs. This means rent for tenants and PITI for homeowners. Back-end ratio indicates the percentage of income that will go towards the payment of recurring debt payments including those in front-end ratio and other debts like credit card payments, car loans, student loans and so on.
Debt to Income: Importance
Given that debt to income ratios measure how much one can pay towards a debt incurred, we can’t afford to underestimate the importance of this concept. This information is important to lenders as it allows them to be sure if you would be able to repay your debt without default.
For instance, if you are looking to buy a house and need to apply for a loan from the bank, the bank will want to ensure if you will be able to afford to pay them back. One way banks consider the ability to do so is by ensuring that the total debt you incur does not exceed a certain percentage of your income.
Usually, they allow between 36 to 42 percent of your income. Apart from this, knowing your own debt to income ratio also allows you, the borrower to monitor your financial liabilities. Keeping an eye on the debt to income ratio by using a debt calculator for a mortgage you have taken is important so that you can avoid over extending yourself. It’s important to help you avoid reach the point of bankruptcy. The debt calculator will also allow you to know if you could afford to invest in another home or upgrade to a bigger home.
How to calculate debt to income ratio
It is important to know how to calculate your own debt to income ratio. This can be done using online debt ratio calculators which are easily available on the Internet. Calculating your debt to income ratio is easy and does not cost a penny. There are essentially two main methods to calculate this figure. The methods basically rely on debts included in the calculations. The easier way of doing so is to compare all housing debts and this includes mortgage expenses, home insurance, taxes and all other house related expenses. Once you have this figure, divide it by the amount of gross monthly income that you receive.
For instance, if you earn a monthly amount of $3000 and your total expenses for house is estimated to be about $1000 a month, then your income to debt ratio would be 1000/3000, which is about 33.3 percent. The second and more comprehensive measure is to add the total amount of money that you spend every month toward repaying all sorts of debts that you may have. These could be credit card payments, mortgages, car loans and so on. Once you add up all these figures, keep the number handy. What you need to do next to is to calculate your monthly income. It can be a sum of your fixed monthly salary and all other bonuses or payouts that you may receive, calculated on a monthly basis.
Finally, calculate all additional income you may receive like side businesses, additional income and so on. A total of all these figures will be your total monthly income. Now, take your total debt payment amount and divide it by your total monthly income. The figure that comes up will be your debt to income ratio. These figures can easily be computed on an online debt ratio calculator. All you need to do is to key in all applicable figures on the online calculator. However, be sure to keep an updated list of all monthly income and debt payments before calculating.
A debt to income calculator for a mortgage is a good way of assessing if you qualify for an investment that you are looking for. Not only should you always use the debt ratio calculator when considering putting your money into an investment, but also on a regular basis so that you stay within your household budget. This can help you prevent yourself from running into unexpected expenses.