Understanding Debt to income Ratio Calculation
One of the most important sign you should always monitor when it comes to dealing with debts is the debt to income ratio. It is simply a percentage used to describe how much your debts are compared to your income. Lenders use debt to income ratio to calculate your credit worthiness, while you can use the same percentage to determine if you are dealing with too much debt.
Calculating debt to income ratio is actually pretty simple. First, you need to assess and calculate all your debts. This includes credit card debts, any secured debt, and other obligatory expenses such as insurance that you need to pay each month. With the amount properly calculated, you can move on to the next step.
Next, calculate your net income. If you have £5,000 of income each month and you spend £2,000 on personal needs –such as food, electricity bills, etc. – then your net income is £3,000. Calculating debt to income ratio must always be done using net income instead of general income, since it will give you better results. Additional income such as investment earnings can still be added to your net income.
Now, divide the total debt you need to repay each month by your net income; multiply the result by 100 and you will have the result in percentage. If your debt to income ratio is anywhere above 30%, you should really consider assessing your debts and formulate a plan to repay them. If you can, keep your debt to income ratio below 20% to keep your personal finance well controlled.