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income to debt ratio
The Debt To Income Ratio comes in two parts with reference to the type of debt that you have:
- The first part looks at your income versus housing debt expenditure only.
- The second part looks at your income versus total debt expenditure (housing debt plus other secured and unsecured debt like credit cards).
Maintaining a good Debt To Income Ratio is important. Although general guidance provides an indication, a good Debt To Income Ratio is regarded as something below the debt limits for each of the two parts:
1. Front End Debt To Income Ratio - Housing Debt < 28% Limit
Your income to debt ratio in respect to housing cost. How much of your gross monthly income goes towards housing. Rent, or mortgage plus property tax, plus home hazard insurance. An income to debt ratio is the first and fundamental thing that a prospective mortgage lender computes. It is an income to debt ratio for a prospective debt situation, i.e., what would your ratio BECOME - If they lend the amount that you seek?
A Debt To Income Ratio is an indication of your ability to repay the debt and is used as one lending criteria. You can also determine your own current and existing ratio of housing debt. What is Debt To Income Ratio part one? General guidance suggests that the part one ratio should not exceed 28%.
2. Back End Debt To Income Ratio - Total Debt (Housing Debt Plus Other Debt) < 36% Limit
Your income to debt ratio in respect to housing plus other routine debt repayments (debt recurring). This Debt To Income Ratio goes further to consider your entire debt situation - that is, your total debt. General guidance states a figure of 36% as the debt limit; the point beyond which you are considered to be overly extended.
This ratio may be thought of as your "Total Debt To Income Ratio".
In addition to your rent cost or mortgage (plus associated) cost, you likely have further household debt. This is known variously as recurring, installment or revolving debt and includes for example:
- Auto Loan
- HELOC or HEL
- Personal Loan
- Credit Card Debt
- Store Card / Purchase Financing
- Other Unsecured Debt (e.g. unpaid medical bills)
The list for establishing your income to debt ratio should reflect monies that have been lent to you (secured or unsecured borrowing, where there is a creditor awaiting repayment). The income to debt ratio only considers debt; for example, this list does not include utility costs or routine service bills. There must have been lending involved.
Your Debt To Income Ratio is useful to know because it provides a way to measure your fiscal health. In theory, the better the Debt To Income Ratio, the better your financial circumstances should be. The ratio or percentage figure may be considered your Debt Limit. You can set your own debt limit or follow general guidance. Your debt ratio percentage limit is the figure that should not be exceeded.
If you are near, at, or beyond 36% for total debt then you should:
- Not seek any new loan
- Refuse all further lending offers
- Stop using credit cards altogether.
- Stop drawing further on available lines of credit
- Take no store financing
- Begin managing debt through one or more alternatives for Debt and Consolidation
You can see the choices and find the options available for managing debt on this website. Being aware of each Debt To Income Ratio allows you to:
- Know if borrowing is sensible and calculate how a new payment would affect your income to debt ratio
- Avoid over-extending yourself and increasing financial risk
- Avoid a negative credit report through rising income to debt ratio
Even where your total Debt To Income Ratio is below 36%, as your percentage figure rises you risk not being able to secure a new loan e.g. for a car. You also risk not qualifying for a favorable interest rate making borrowing more expensive. Towards the goal of best financial health, the recommended debt to income ratio is as low as possible. Each ratio would be less than the guidance (Front 28%, Back 36%). You should not confuse the idea of a recommended debt to income ratio with the maximum acceptable debt to income ratio allowable by a prospective lender assessing your application for a loan. In many cases lenders will accept higher debt limits for the purpose of qualification. That does not mean that you would be wise to borrow. What is the average debt to income ratio? These days, many people increasingly have a total debt to income ratio (Back End) between 40-49%. 40's is poor and affects creditworthiness. Above this income to debt ratio figure you would be considered in financial peril and living very riskily. Debt to income ratios are a useful tool in the war against debt. Use these debt to income ratios to establish your current position. Ask yourself, what is my debt to income ratio? Next we look at how to figure debt to income ratio.