What is the Debt to Income Ratio?
The Debt to Income ratio is a financial calculation used to reveal the percentage of a consumer’s monthly gross income. As a result, the solution of the debt to income ratio will yield the individual’s income that goes toward paying debts. The debt to income ratio, however, will generate a figure that can cover more than just the individual’s debts; the solution can include certain fees, taxes and insurance premiums as well. Nevertheless, the debt to income ratio is a phrase that serves as a convenient calculation.
Types of Debt to Income Ratios
There are two fundamental types of debt to income ratios; both calculations are expressed as a pair using the notation x/y. The first debt to income ratio, labeled the front-end ratio, will indicate the percentage of income that goes toward housing costs, which for renters is their rental payments and for homeowners is their mortgage principal plus interest, their hazard insurance premium, property taxes, homeowner’s association dues and their mortgage insurance premium.
The second form of the debt to income ratio, known as the back-end ratio, indicates the percentage of income that aims to satisfy all recurring debt payments, including those covered by the front-end debt to income ratio and other payments, such as credit card payments, student loan payments, car loan payments, child support payments, legal judgments and alimony payments.
How do I calculate my Debt to Income Ratio?
In order to calculate the debt to income you must first select what type of debt to income ratio you are attempting to use. For mortgage payments or rental costs you must compare all of your housing debts, which may include your mortgage expense, home insurance, rental payments, taxes and any other housing-related expense.
Once you have added your monthly costs you have appropriately calculated your total housing expense. Following this calculation, divide this amount by your gross monthly income. For example, if you earn $2,000 per month and have a mortgage expense of $500, taxes of $200 and insurance costs of $150, your debt to income ratio is 42.5%.
The more encompassing debt to income ratio will include all other expenses associated with recurring debt payments, such as those listed previously. When these figures are added in, your ratio will increase and the remaining percentage will quantify your monthly disposable income—monies left over after all debts have been paid that are required to by food, clothing and personal items.