You might hear news reports or read articles that talk about how consumers carry too much debt. But how much is too much? What is it measured against to determine if the level is acceptable or not? The most common measurement is called a debt-to-income ratio. Financial lenders use two variations of this ratio to determine whether your debt as a percentage of your income is at an unacceptable level.
The Percentage
The generally accepted percentage of debt to income is 36, meaning that your monthly debt payments should make up not more than 36 percent of your gross monthly income. Your housing costs should be not more than 28 percent of your income. This leaves 8 percent of your income for other debt.
What's Included
Housing costs are considered to be the principal, interest, real estate taxes and homeowners insurance that you pay each month. If you are renting, it will be your rent and renter's insurance payments. These are the amounts that should not exceed 28 percent of your income. The remaining 8 percent should cover car loans, child support and alimony, credit card bills, student loans, condominium fees and any other debt you have.
Calculations
To make the determination of what your debt-to-income ratio is, begin with your income. Look at your income before taxes are withheld. If you are paid bi-weekly, you will need to multiply this amount by 26 and then divide by 12 to get your monthly income. If your pay varies from week to week, you will need to calculate an average pay over a few months and then determine your monthly pay using that average. Multiply your monthly gross income by .36 and the resulting answer is the upper limit that your debt can be before financial institutions consider it too high for a loan. Next, total your monthly debt and divide it by your income to see what your percentage is.
If It's Too High
If your debt is too high, then you should work to reduce that percentage. You can do this in two ways. Pay off more of your debt so that your total debt is reduced. You may need to reduce other spending in order to put more toward your debt payments for a while, but your goal is to reduce your total debt. The other thing you can do is earn more. This might be harder because you will probably need to take on a part-time job or work more hours at your current job. With a greater income, the same amount of debt will represent a smaller portion of the income.
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