Lower Debt to Income Ratio
The debt to income ratio is one of those financial calculations that surface when you are trying to qualify for a mortgage, but they are hardly ever thought of before, or for that matter, after the mortgage issue is settled. A lot of people wonder, how is it possible to lower the debt to income ratio?
What exactly is the debt to income ratio?
The debt to income ratio gives a snapshot of your ability to repay your loans. Thus, it is simply a measure of your attractiveness to financial institutions. Banks prefer debt to income levels that are less than 35% because this means that currently 35% of your gross income is used to repay debt obligations. This is considered an acceptable level and generally indicates that you should be able to handle additional credit and still manage to stay on top of your other living expenses.
How is the debt to income ratio calculated?
The debt to income ratio is a surprisingly simple calculation. To do it yourself, you need to find the total of your household debt. This may include car loans, student loans, credit card bills and any other personal loans. You should not add what you spend on groceries or any other discretionary expense as only actual debt commitments are included.
The next step is to divide the total debt expense by your total gross income. This is your income before taxes are deducted. From the description of how the debt to income ratio is calculated it should be apparent that this ratio is only an estimation of how much additional debt you may be able to carry.
This is because gross income is used which does not consider taxes that will not be available to help towards loan payments. Also living expenses are not factored into the equation, so again in reality this reduces the actual cash flow available to repay loan installments. The take away here is just because you can qualify for a sizable mortgage doesn’t mean you can afford it. You need to examine your willingness to make lifestyle sacrifices and then take on what you would be comfortable repaying.
Why is the debt to income ratio important?
The debt to income ratio is important because it is the measure used by all financial institutions to help determine how much they are willing to lend you. It therefore affects the amount of money you will have to spend on your house.
What if your debt to income ratio is too high?
If you have an extremely high debt to income ratio and it is crippling your ability to qualify for a mortgage all is not lost. You can either find ways to decrease your outstanding debts or increase your income. To reduce your debts you can use savings to pay off balances on loans that are close to completion or implement cost cutting strategies that free up additional money that can be used toward debt repayment.
To increase your income you may be able to ask for a raise or establish another source of income from starting a business or taking a second job. Increasing your income may be harder or take longer than cutting down the expenses, but the option is there.
Keep tabs on your debt to income ratio
Now that you are aware of how easy it is to calculate your debt to income ratio, you can start checking your ratio every quarter to monitor changes in your financial health. Bear in mind that additional debt without increases in income will increase your ratio and the closer you get to 50% the nearer you are to probable financial ruin. Keeping one eye on your debt ratio can therefore help to ensure that you are on the track to financial freedom and not headed in the opposite direction.
Sal Orlando is a debt specialist for Debtfreedestiny.com, a financial services provider in the credit card consolidation industry. Visit Debtfreedestiny.com to find the financial resources you are looking for today!