Give Your Debts a Financial Health Check

March 21, 2008

Woman Workout

How healthy is your financial situation?  Here’s how you can determine your financial health!

A debt-to-income ratio is a measure of financial stability calculated by dividing monthly minimum debt payments by monthly gross income.  Many lenders use debt-to-income ratios to help determine whether a borrower is overextended or not. 

This calculation gives a straightforward depiction of your financial position.  Typically, the lower your ratio, the better handle you have on debt.  Here’s how you can calculate your debt-to-income ratio:

First, determine your debt

* Collect your most recent credit billing statements for current balances on all loans and credit cards
* Outline your total monthly bills using two columns: bill type (such as car loan, mortgage/rent payments, credit cards, and so on) and monthly payment.  Do not include bills such as taxes and utilities in this list.

* Add up the total for all of the monthly payments listed.

* Calculate your monthly before-tax income.  If you receive a paycheck every other week, as opposed to twice a month, your monthly gross income is your before-tax income from one paycheck times 2.17.

* Your monthly debt-to-income ratio is calculated by dividing your monthly debt payments by your monthly income.  For example, someone with a monthly income of $2,000 who is making monthly payments of $500 on loans and credit cards has a debt-to-income ratio of 25% ($500 / $2,000 = .25 or 25%).

What range your debt-to-income should be is subjective.  But, generally speaking if you keep it below 35%, you should be in good shape.  And, remember – the lower your debt-to-income ratio is – the better!

Take a look at your debt-to-income ratio, and look for ways to reduce that percentage!