In the finance world, the debt ratio is used to measure the amount of leverage a company is taking by comparing the amount of debt a company has to its assets. When it comes to personal finance, we can use the debt-to-income ratio as a measure of the financial risk present in our own circumstances. The ratio is calculated as follows:
Debt-to-Income Ratio = Total Monthly Debt/Total Monthly Income
Let’s say you currently have a mortgage payment of $2,500 and vehicle loan payments totaling $500. Your current monthly debt is $3,000 ($2,500 + $500). Your collective monthly income is $7,500. This means that your debt-to-income ratio is 40% ($3,000/$7,500 = .40).
When it comes to qualifying for a mortgage most lenders want to see a score in the low 40s or lower (including the loan they would be making you). This tells them that you have the capacity to make the payments on the money they’re lending you. If you’d like to lower your debt-to-income ratio, there are two ways to do so: reduce your monthly recurring debt or increase your monthly income. If you find yourself needing help with either of these objectives, please feel free to give us a call!