Calculating your Debt Ratio

Posted 19 Mar 2015 by Melissa Allan

Most of us have debt with the goal of becoming debt free down our path in life. As a Financial Security Advisor, I cannot stress how important managing your debt is. A savings of 0.5% to 1% on an interest rate on a big ticket item such as a mortgage is HUGE over the amortization period of your mortgage. It’s so important to pay attention to the interest rates you’re paying and I highly recommend using brokers for this purpose or to shop the rates yourself. My experience tells me that unfortunately, many people don’t shop rates and they believe their bank is giving them the best rate. The banks are like the cable companies! Unless you threaten to pull your business you’re often not getting the best offer out there. It’s actually sad that we as consumers have to play this game to get the best rate. I’m not saying everyone has too, but in general it’s the whole “you won’t get it unless you ask for it”.

I feel understanding your credit score and your debt to income ratio is important when applying for such loans or better interest rates. If you have excellent creditor and/or a good debt ratio if should give you the confidence you need to negotiate a better rate as lenders want YOUR business!

The debt to income ratio is often brought up when applying for loans such as a mortgage, line of credit or auto loan as this ratio determines how much debt you can “handle”. Most of the major lenders consider a healthy debt to income ratio 30% or less. If you are bordering the 40% range it raises a big red flag to lenders. If your debt ratio is close to or above 40% I highly recommend you get help because you’re considered a vulnerable household and you don’t have any breathing room if interest rates rise.

Simply put, this calculation takes your gross monthly income (not net) and, if applicable, your spouse’s monthly income. Then you add up all of your debt payments such as a mortgage, credit card, line of credit payment, student loan, etc…) Divide your total monthly debt payments by your monthly income, multiply by 100 and you have your debt-service ratio.

If you calculate your score and are worried your ratio is too high, call our office and we can look at your overall financial health by not only looking at your investments but looking at your debt and working with you to find solutions to put you back on track.