What Is a Debt-to-Income Ratio and Why Is It Important?

Before making a solid budget it’s important to understand your debt to income ratio. Let’s unpack what that means and how it affects the decisions you will be making regarding your finances.

Understanding your finances is the key to making sound financial decisions. Only by taking an active role in your personal economy will you be able to maintain a positive financial future. One of the biggest factors affecting your budget will be your debt-to-income ratio. But what does that mean? Let’s take a look!

Debt Divided by Income

To find your debt-to-income ratio, add up your recurring monthly debt and then divide that number by your gross monthly income. This will be reflected as a percentage. For example, if your total bills come to $1,500 per month, and your gross monthly pay (gross means before taxes and deductions!) is $2,000, your debt-to-income ratio would be 75%, meaning 75% of your income is spoken for prior to your other needs.

$1,500 / $2,000 = 0.75

0.75 = 75%

If these figures are hard to track due to fluctuating hours at work or commission-based pay, use an average of several months to get your gross income. Just keep in mind when creating your budget that some months will be leaner than others, and you will need to compensate by saving the extra dollars in the good months.

Why Does This Matter?

There’s no way to establish a budget without understanding exactly how much you bring in each month and how much is going out. Some things are harder to track, especially if you have random purchases such as eating out or shopping. But for debt-to-income ratio, we are concerned only with actual debt. Recurring obligations that must be met every month, such as student loans, car loans, or mortgages.

This exact number is going to be used by banks and creditors to determine if you are eligible for a mortgage or line of credit, and if the percentage is too high you will not qualify. So even if you aren’t aware of what your debt-to-income ratio is, creditors will still use it to make decisions about you.

How Do I Bring Down My Debt-to-Income Ratio?

There are only two ways to lower your ratio. Increase your income or lower your monthly debt. The more money you bring in and the less money that goes out, the lower your ratio will be. Your ratio will change over time as your debts get paid down and your means of income increase, so be sure to recalculate as time goes by. The real key is dedication. By setting a strict budget and sticking to it, you will cut out needless spending and get your finances back on track.

How CreditGUARD Can Help

CreditGUARD is ready to help you get your debt under control using our non-profit debt management program so that, over time, you can start to bring down your debt-to-income ratio to a manageable level that you and creditors can be comfortable with. Our certified credit counselors can help you review your monthly credit card debt and your expenses to design a budget just for you. Call [cga-phone] today and see what CreditGUARD can do for you!


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