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Your Debt to Income Ratio – the “Common” Way & the “Healthier” Way

by yak max

How much debt should you have? Or better said, how much debt should you not have? Your debt-to-income ratio is more important than you think. Your debt-to-income ratio, or DTI, figures very heavily into your credit rating. Your DTI is very simple to calculate, and as its name explains, it is the ratio of debt you owe against the amount of income you bring in. What is calculated is the amount of free cash you have after meeting your debt obligations and this number is very important to your financial health as well as to your credit and creditors.

If you want to find out what your DTI is now and compare it to where it should be, keep reading. But be prepared to be shocked!

In order to obtain your DTI, you do not need a fancy calculator, simply start by adding up all of your monthly debt payments. These include your mortgage payments, auto payments, credit card and loan payments. It does not include things like your utility bills or grocery budget. Let us assume that this number is $2,300.00. $2,300 is what you pay out each month for your debts.

The “Common” Way of figuring your DTI is to now take your combined household gross yearly income, let us say it is $80,000 and divide that by 12 months. Which would give you $6,666.00. To get your DTI simply divide: $2,300 / $6,666.00 = .34 or 34%.

34% is a healthy DTI. The key number is 36%. You want to keep your DTI at 36% or below.

Figuring your DTI the “Common” Way does not take into account taxes and other deductions such as retirement and health insurance premiums. These things are your debt obligations as well and so they too must be accounted for. Therefore, let’s figure your DTI the “Healthier” Way.

The “Healthier” Way of figuring your DTI is to do the exact same thing, except instead of taking your combined household gross annual salary and dividing it by 12, simply use you total combined monthly household take-home pay, or net salary. Let’s say that out of the $6,666.00 gross, you actually only bring home $4,800.00 of that net per month. Therefore, $2,300 / $4,800 = .47 or 47%. You can see that shockingly, this is a much higher number. But it is also more accurate to what it would take to be not only financially healthy but income happy.

Work to bring your DTI, figuring it the “Healthier” Way, down to 36% or below. This would mean that if you did bring home net per month $4,800 that your total monthly debt outgo should be no more than $1,728.00.

If this seems like a low number to you, if it seems like you’d have to downsize your lifestyle to get there, take into account that although you might be downsizing home and car, you are increasing your cash flow which will increase your ability to enjoy life more. It will also enable you to save for retirement more comfortably, hopefully ensuring that during your golden years, your lifestyle doesn’t have to change and you can afford to be happy and free.

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