Debt to Income Ratio for Personal Financial Health

With easy access to credit cards and perhaps having income from more than one source, it can be easy to use the credit card and checkbook without much thought. However, if you do, even if you make all of your minimum credit card payments on time, you could be hurting your financial health by raising your debt-to-income ratio. Your debt-to-income ratio is the amount of reoccurring debt you have divided by your income after taxes. Calculating it can open your eyes to the amount of money you have available to put toward your other expenses each month.

Healthy Ratio

According to Care One, a debt relief service, a healthy debt-to-income ratio is anything below 36 percent. However, it is helpful to have a lower debt-to-income ratio, and increasing your ratio to near 36 percent might be a ineffective strategy if you have no plan or ability to pay off some of that debt quickly or to raise your income. Most lenders use the 36 percent debt-to-income theshold to determine whether they will approve a loan and the interest rate you will pay, according to the LendingTree website. However, your debt-to-income ratio affects more than just your ability to qualify for a loan. It also determines whether you have enough income to pay your debts and still have enough money left to satisfy your basic needs, invest in your family's future and maintain your desired lifestyle. If you calculate your debt-to-income ratio and determine you only have $50 left per month after bills and expenses, you don't have a healthy ratio.

Debt-to-Income Ratio and Loans

While some lenders will not offer loans to people with debt-to-income ratios above 36 percent, others will, but the interest rate they offer is likely to be high. Many mortgage lenders require that your housing expenses alone not exceed 28 percent of your monthly gross income, according to LendingTree. However, some government loan programs, such as those loans insured by the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA), may set a higher threshold for the debt-to-income ratio of its borrowers. Regardless of whether you are approved for a loan based on your debt-to-income ratio, you should calculate your ratio before signing the papers. Use it to gauge your financial health, and dont sign the papers if you believe the loan will raise your debt-to-income ratio too much to meet your expenses.

Preparing for Unforeseen Circumstances

Calculating your debt-to-income ratio is helpful in preparing for unforeseen circumstances. While paying more than half of your income toward your debt may be comfortable when you have a large income and your debt represents investments, things may be different if you lose your job or face unexpected medical expenses. Consider these issues before you raise your debt-to-income ratio.

Getting a Healthier Ratio

One way to achieve a healthier debt-to-income ratio is to pay off some of your debt. If you suddenly come into a large amount of money, such as a tax refund, gift or inheritance, consider allocating some or all of it to debt repayment. This will reduce the amount you owe and give you a lower, healthier debt-to-income ratio. If you can do that, you also must try to avoid accumulating debt in the future.