The relationship between the amount of debt you have and the amount of money you bring in each month is called your debt-to-income ratio. Keeping the maximum amount you spend on debt each month below recommended levels not only helps to keep you from running out of money by the end of the pay period, but it also boosts your ability to obtain new credit when you need it.
Maximum Debt Payments
Your total debt should not exceed 36 percent of your net monthly income, according to Bankrate. Therefore, if you bring in a gross monthly income of $4,000, you should spend no more than $1,440 on your debt obligations. To calculate your total debt-to-income ratio, take your yearly salary and multiply it by 36 percent. Then divide that number by the number of months in the year, 12. The result is your maximum debt-to-income ratio, which you shouldn't exceed if you want to maximize your credit score.
Types of Debt
Your total allowable debt means all of your debt, including your mortgage, credit card balances, student loans, car loans, child support, alimony and any other debt you've accumulated. When you're calculating your maximum allowable debt, you must carefully consider debts that are specific to your own life. Ten percent of your credit score is determined by the diversity of your debt, which means having both revolving debt (credit cards and lines of credit) and installment loans (mortgages, student loans, car loans).
Managing Debt
For those whose debt payments exceed 36 percent of their monthly income, it's vital to pay down balances as quickly as possible to get to the figure resulting from the maximum debt-to-income ratio calculation. People with unmanageable or very high debt-to-income ratios should visit a reputable credit counseling organization recommended by the National Foundation for Credit Counseling. Debt consolidation, debt management plans, and self-help plans (such as paying off the debt with the lowest balance or highest interest rate first) are all methods to help debt ridden individuals become debt free.
Considerations
Your debt-to-income ratio plays a large role in whether or not you qualify for loans and how much you qualify for. This figure is a tool that lenders use to determine how much of a risk you are as a borrower, and whether or not you'll realistically be able to pay back the loan. While not quite as vital as your credit score, your debt-to-income ratio is a big part of the application process for new loans.
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