By David Pilley on July 14, 2010
.jpg.aspx?width=75&height=75) Chances are you have debt. Chances are that you also make income. When paying off your debt, you need to maintain a budget and keep track of a few different numbers. Lenders also keep track of these numbers when deciding whether or not to give you a loan. One of the most important numbers to keep track of when you are in debt is your debt-to-income ratio.
Debt-to-income ratio, or DTI, is the percentage of your gross income that goes toward paying debt. There are two types of DTI: front-end and back-end. Front-end DTI is the percentage of income that goes toward your housing costs, including your mortgage, taxes, and home insurance. Back-end DTI consists of your front-end DTI plus the rest of your debts, like car loans, student loans, and credit card balances. The front-end DTI is one of the most important factors a lender uses when determining whether or not to give you a mortgage loan, while the back-end DTI is most often used to determine whether or not you can open up a new credit card account.
Your debt-to-income ratio is an indirect factor in your credit score, as well as determining whether or not you will receive a loan. Since it is a ratio, it can be translated into a percentage, and it is a fairly easy number for you to calculate. To find the monthly ratio, divide your monthly gross income (take-home salary plus bonus and overtime pay) by your total monthly debt. If the percentage is zero, congratulations on not having debt. More likely than not, though, you will have debt. For healthy finances, an optimal front-end DTI (for housing costs only) can be up to 28%, while an optimal back-end DTI (all debts) is up to 36%. (Your back-end DTI will always be higher than your front-end DTI, since it consists of all your debts.) For example, if you make $3000 a month and you have a $600 mortgage with $300 in property taxes and a $100 insurance premium, your front-end DTI will be 1/3, or 33.3%. Since this is higher than the 28% benchmark, this is a slightly dangerous number, especially if you have credit card debts, car payments, and other non-housing related debts factoring into your back-end DTI. To maintain a healthy credit score, you need to keep a budget and keep track of all your bills. Finally, when determining your debt-to-income ratios, remember the numbers 28 and 36, and you should be in business.
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