The word “debt” is often associated with images of stress, past due notices, piling stacks of bills, and possibly a low credit score. However, if managed properly, debt can be a good thing. In fact, some debt is almost always necessary if you want to acquire certain things like a home, new car, or higher education. The question most individuals want answered though is “How much debt is too much debt?” In other words, at what point does debt become unmanageable?
How Do We Measure Debt?
One of the most efficient ways to measure your debt is to calculate your debt-to-income (DTI) ratio. Your DTI ratio is essentially a comparison of all your monthly debt obligations and your gross monthly income. This ratio is used often by lenders to measure your ability to repay money you want to borrow from them. DTI ratios are read as percentages. The lower the percentage, the less of a risk you are considered to lend to. On the other hand, a higher percentage can indicate that you may borrow more than you can afford to repay, thus making you a risky borrower.
How Do I Calculate My Debt-to-Income (DTI) Ratio?
You can calculate your debt-to-income ratio by taking all your monthly debt payments and dividing it by your gross monthly income. Your monthly debt payments should include bills like:
- Monthly rent or mortgage payment
- Auto loan payment
- Student loan payment
- Other loan payments
- Alimony or child support payments
- Minimum credit card monthly payment
- Other debts
Once you tally up the total cost of your monthly debt, divide it by your gross income. This is your income before taxes are removed. For example, let’s assume you earn $6,000 per month before taxes. Your monthly debt obligations include a $1,500 rent payment, a $300 car payment, and a $100 credit card minimum payment. Your total monthly debt adds up to $1,900. If you divide that by your $6,000 monthly gross income, you end up with a DTI ratio of about 32%. What does this mean though? Next, we’ll discuss what a good DTI ratio is and how you can improve yours.
What Is a Good Debt-to-Income (DTI) Ratio?
When it comes to DTI ratios, there’s a scale that is widely used that helps determine if we have too much debt.
- A DTI ratio of 36% or less is considered good, meaning your monthly debt obligations are considered affordable compared to your monthly earnings.
- A DTI ratio between 36% and 42% is considered borderline, meaning that you may need to look into how you can pay off some of your debt until you can lower your ratio.
- A DTI ratio between 43% and 50% is considered bad, meaning it’s time to take action to reduce your debt. You may consider seeking help from a debt relief agency.
- A DTI ratio of 50% or more is considered a very high risk. At this point, it may be time to consider serious measures, like bankruptcy, to relieve the issue.
How Can I Reduce My Debt Obligations and DTI Ratio?
If your debt still feels manageable, but you find your DTI ratio is borderline, you might want to to begin taking action to reduce your debt to avoid falling into the bad DTI range. The most obvious thing to do is to pay down some debt. If you cannot pay off debt immediately, another option is to consolidate your credit cards to lower your monthly payment. If you have other loans, you may consider refinancing those. If your DTI range is in the bad range, it’s important to take serious action soon. Seeking help from a debt relief company can make the debt repayment process much easier and worry-free. Debtmerica Relief has over 16 years of experience in providing relief to our clients whose debts have become too much to handle. If you need help with debt, give us a call at 800-470-8155 for a free consultation.