How to Calculate Your Debt

It’s extremely important for people to monitor their credit and to stay on top of debt by calculating it. With more than 40 million Americans currently struggling with bad credit, learning how to calculate your debt can help you avoid some of the pitfalls of bad credit. Keeping yourself creditworthy ensures that when you go to make a major purchase, such as a car or home, you will be approved. Calculating your debt to income ratio is easy and it's also useful knowledge to have when applying for any type of loan. Continue reading and find out a little more about this ratio and why it’s so important to you.

Why is Debt-to-Income Ratio Important?

Debt-to-income ratio, also known as DTI, is used by lenders to determine how overextended a borrower is financially. Simply put, debt-to-income ratio is the comparison between the amount of debt you have, not including mortgage or rent payments, and your income. Creditors or lenders will look at your debt-to-income ratio to determine your risk level. Someone with high DTI ratios poses a larger risk to the institution. High debt-to-income will make it difficult to qualify for a loan or obtain credit, and may prevent you from getting the lowest rate. The best way to ensure you get the most favorable terms and rate available is to be sure you have a low debt-to-income ratio.

How to Calculate Debt-to-Income

Debt-to-income is easy to calculate by hand, and there are a number of free online debt calculators available as well. Staying on top of your DTI can help you avoid gradual debt. Gradual debt sneaks up on you, and before you know it, you’re in over your head. Calculating your debt fairly often will help you spot rising debt early so you can get a handle on it. To calculate your percent of debt, take the amount of debt you pay per month and divide it by your income, minus deductions. Income includes salary, child support or alimony, bonuses and commissions as well as earnings from any stock dividends and interest. Debt is any loan or credit obligation that you pay each month, excluding mortgage or rent. For example, if your take home pay is $2000 and your monthly debt, including all loan payments and credit debt is $700 per month, your DTI would be 35% or $700 divided by $2000.

Keep your Debt-to-Income Low

Keeping your DTI low is vital to maintaining your creditworthiness. You never know when an extra credit card will help in an emergency, or when you need to obtain financing for an unexpected purchase. Checking your debt-to-income often will help you stay on top of rising debt and budget better.  Avoid making many small purchases on your credit card, or running high balances. Use your card for things you know you will be able to pay off before interest accrues. If you must carry a balance, pay early and always send more than the minimum payment. Make a plan to pay off your debt as quickly as possible to keep revolving or installment debt from negatively affecting your debt-to-income ratios. Bear in mind, a DTI higher than 36% is a red flag to most creditors and lenders so do what it takes to keeps yours lower than that.