Your debt to income ratio shows your financial health and lenders use this ratio to evaluate your creditworthiness. This ratio tells lenders what percentage of your monthly income can be used for your loan payments (or mortgage payments).
As it sounds, your debt to income ratio compares your debt to income. This is a monthly figure. To calculate debt to income ratio, take your monthly debt payments (minimum payments) and divide it by your gross monthly income.
Example: Monthly debt payments include:
- Credit card payments, loan payments, car payments etc.
- Don’t forget to add investment income
- Rental income etc
Let me give you an example. Let’s say your gross (before taxes) monthly income is $1000
And your monthly payment is $100. Your debt to income ratio is $100 divided by $1000 = 10%.
Tips: When you add monthly mortgage payment to above to above calculation, it becomes the back end debt ratio. If you remove monthly mortgage payment, it becomes the front end debt ratio. Front end debt ratio tells lenders how much monthly mortgage payment you can afford. To qualify for a mortgage, you would require something like 25% to 28% front end debt ratio. With a mortgage, back end ratio should not go beyond 45%. So you can see that in general the lower your debt to income ratio, the better you are healthy financially.
First Published: Oct 17, 2007 ADawnJournal.com