How to Calculate your Debt to Income Ratio

How to calculate your debt to income ratio

Your debt to income ratio is a personal finance measure that lenders use to determine how likely they are to receive a payment from a borrower. It compares the amount of money you earn to the amount of money you pay toward your creditors. The below calculation is one used by mortgage lenders and will give you a better overall picture of your finances.

Calculate income:

Annual gross salary (before taxes)
Annual bonuses and overtime (before taxes)
Other income (including alimony)
Divide this amount by 12.
This will be your total monthly income.

Calculate debt payment:

Monthly mortgage payment (including taxes and insurance) or monthly rent
Monthly home equity loan or line of credit payment
Monthly auto loan payment
Monthly student loan payments
Minimum monthly credit card payments
Monthly loan payments
Monthly child support payments
Add these together for your total monthly debt payments.

Divide your total monthly debt payments by your total monthly income and you have your debt to income ratio.

Now that you have calculated your debt to income ratio, what does it mean to you?

If your debt to income ratio is less than 36% you are carrying a healthy debt load. If you range between 37% – 42% you should begin to pay down your debts now before they get too far out of control. 43% – 49% is an indication that your debt is beginning to overwhelm your finances and you need to take immediate action. If you are 50% or higher you need to seek professional help now to reduce your debt!

When analyzing your debt to income to qualify you for a loan, lenders determine two factors: front and back end ratios.

Your front end ratio is calculated as a percentage of your income dedicated to paying your mortgage each month and does not include all of your recurring debt payments. Your mortgage payment will consist of four parts: principal, interest, taxes and insurance (PITI). To qualify for an FHA loan, your front end ratio should not exceed 29%. For a conventional mortgage, a comfortable ratio is 33% however many lenders today will factor in a ratio as high as 40%.

Your back end ratio is higher than your front end and calculates all of your recurring debt payments with your new mortgage payment. For an FHA loan the back end is 41% and 45%for a conventional mortgage.

A healthy ratio you should strive for would be a 33/38% however these guidelines are flexible and vary depending on the loan you are applying for.