Household Debt Income Ratios

Debt management is an important aspect of a person's financial well-being. There are a number of ratios that individual's can use to ascertain whether or not they have a good handle on the amount of debt that they have acquired. No person has a set amount of debt that is good or bad, but they must be able to manage it without incurring excessive costs and afford it.

Consumer Debt Ratio

As probably the most widely used debt management ratio, this examines the amount of monthly consumer debt payments to monthly net income. Net income is after-tax income. Adding together all non-housing monthly payments for items such as credit cards, automobiles, furniture, etc., and then dividing by monthly gross income will produce a percentage value. The benchmark, or point of measure, for this ratio is 20 percent.

Monthly Housing Costs to Monthly Gross Income

Many people try to take on a larger mortgage than they can handle. The 28/36 benchmark is a good determinant of affordability.

This ratio examines monthly housing costs, including principal, interest, taxes and insurance (PITI), as a percentage of monthly gross income. Most mortgage payments are PITI payments. Gross income is everything that is earned before taxes are taken out. When PITI monthly housing costs are divided by monthly gross income, the prevailing percentage should be 28 percent or less. This is what is required by most mortgage lenders.

Monthly Housing Costs and Other Debt Repayments to Monthly Gross Income

This is similar to the ratio above, except that the numerator will now include credit card and other monthly debt payments, such as amounts for a car loan. Adding all of these to the monthly housing costs (PITI) and dividing by monthly gross income should equal less than 36 percent. Mortgage lenders will look at this. This also means that only eight percent of gross income is being spent on debt other than housing. The reason this is different from the first ratio is because that was calculated with after-tax income and this with pre-tax income.

Total Debt to Net Worth

While this is not an income ratio, it is an important measurement of how one is measuring their debt. It is an indication of how much of a person's assets was purchased using debt. Over time, this value should decline as debt is paid off. The ratio is calculated by simply dividing total debt by net worth. The lower this value, the less financial risk the person carries, or the less risk of default if something happens to that person's income.