Debt to income ratio: what does it mean?
An individual’s debt to income ratio reveals how much of his income goes towards paying his debts. If a substantial amount of your monthly income is used for repaying debts; you are supposed to have a high debt to income ratio.
What are the types?
• Front Ratio-This type of debt to income ratio reflects what portion of the monthly income of the particular person is spent towards housing costs.
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• Back Ratio-This ratio indicates the percentage of monthly income that is used to pay the housing costs and all type of consumer debt.
Points you should consider when calculating debt to income ratio:
• When you calculate your debt to income ratio, you have to consider your Gross Monthly Income i.e. your monthly income before tax deduction. This is so, because, the Gross Monthly Income reveals your true spending ability.
• If you are a homeowner and trying to calculate the Front Ratio, you have to consider all types of housing costs like mortgage principal, mortgage interests, mortgage insurance premiums, property taxes, homeowners’ association fees etc.
• If you live in a rented house, then you should consider the rent amount in your housing costs, when calculating Front Ratio.
• At the time of calculating the Back Ratio, you should consider not only the housing costs but also other debt items like education loan payments, car loan payments, credit card payments etc.
Debt to income ratio: why is it important?
Debt to income ratio is very much important for you as it helps you to understand your ability to bear debt burden. Most of the creditors assess your mortgage affordability by your debt to income ratio. Low debt to income ratio increases your creditworthiness in the eyes of the creditors. But, if you have a high debt to income ratio, then the creditors will not easily approve your loan, thinking that, you might not be able to repay the debt. If you want easy access to credit, you are required to maintain a low debt to income ratio and in order to do that; you should calculate the ratio each quarter and should manage your debts accordingly.
