What is a debt to income ratio? Understanding your debt ratio
As a consumer, what’s important for you is
- understanding what a debt to income ratio is,
- determining your debt to income ratio, and
- knowing how to use that information to your advantage.
First: what is a debt to income ratio?
Your debt to income ratio is a number that tells you how much your debts cost each month in relation to how much money you’re bringing in. This number can be used to understand your current financial state, like a litmus test for your budget.
Okay, so … how do I find mine?
Find your debt to income ratio by adding up all your monthly bills and debts, and dividing that number by your total monthly income (before taxes).
Here’s an example to show you how to get started:
We’ve added up household bills like mortgage, credit card bills, payments on a line of credit and payments on an installment loan. Then we divide that number by the household’s gross (total) monthly income, $4,000, to find the debt to income ratio, which is 62.5%.
This number tells us that the household in the example above is spending just over 62% of their income on debt repayment, leaving 37.5% for household expenses and savings.
What if my ratio is higher than 1?
If you do this calculation at home and find your debt to income ratio is close to or higher than 1, you’re spending more on debt than you’re earning. This is a clear sign that your finances need help. If you’re spending close to all of your income on debt, or more than what you earn on debt payments, you may want to consider taking greater control of your finances through debt consolidation.
What is an ok debt to income ratio?
Everyone’s financial situation is unique, and changes over time as you take on new debts like a mortgage or car loan and pay off old debts like credit cards or lines of credit. In general, Canadians should aim to spend no more than 36% of your income on debt repayment, leaving the rest of your money for day-to-day costs and saving for your future.
What steps can I take to improve my debt to income ratio?
If you’re looking to reduce your debt and simplify your monthly budget, a debt consolidation loan may be the answer. With a debt consolidation loan you can get the money you need to pay off existing debts immediately, leaving you with one manageable loan payment instead of competing bills.
Our advice? Focus on paying off higher-interest debts first, like a credit card or loan, before tackling lower-interest debts like a line of credit, car loan or mortgage.
This article is for informational purposes only. For personalized financial advice, you should contact a qualified financial advisor.