You’ve heard the expression, “more month than money.” In fact, many Americans feel as if they spend a large portion of their income just paying bills and paying down debt. Of course, everyone wants to have a high income and a low debt. But what is a good debt to income ratio? And what’s the average household debt – is yours normal?
If you’re not familiar with “debt to income ratio,” read on. We’ll look at what it means to have a low debt to income ratio, and at whether your family’s finances are comparable to other families in the United States.
What is Debt to Income Ratio?
Every month, you pay a series of bills. You’ll pay the water, the electric, phone and internet. Maybe you’ve got cable or other subscription services. Then, there’s your rent or mortgage and your car payment. Finally, you’ve got other accounts you owe, like medical bills, credit card debt, tax bills or other items.
On the other hand, you’ve got your income. You’ve probably got a salary or paycheck, and may have other income as well. Income from rental houses, from alimony or child support, and even government assistance money.
Your debt to income ratio, put simply, is the amount of money you’ve got coming in compared to the amount of money you’re paying out. Creditors will look at this ratio to determine whether you’re ready to take on another monthly payment.
When banks are figuring your debt to income ratio, there are certain things which are not included. Your utility payments, for instance, aren’t included in your debt to income ratio. Additionally, payments like child support may not be included in the formula. You’ll usually be given the option.
Bills which are factored into the calculation include:
- Monthly credit card payments
- Medical bill
- Car payments
- Rent or mortgage
- Student loans
- Child support you pay
- Alimony you pay
Your income is generally all incoming money, excluding child support if you choose not to include it.
How to Calculate Your Debt to Income Ratio
To calculate your debt to income ratio, you’ll obviously need to know what’s coming in and what’s going out. Sit down with your laptop, or a stack of your bills, and calculate all your monthly expenses. Include all the items we talked about above, from your credit cards to your rent payments. Add those numbers up.
Then, you’ll need to see what’s coming in. Obviously your salary will be one of the items. You’ll also need to consider whether you’ve got any other regular incoming payments. If you’re like most people, this shouldn’t be too hard to figure out. Just make sure you don’t forget about things like unemployment checks, social security or other payments.
Finally, just do the math. Divide your total monthly payments by your total monthly income, before taxes. The result is your debt to income ratio, and it’s expressed as a percent. Be sure to move the decimal in your answer over two places.
So now that you’ve got your debt to income ratio, you’ll need to know what that information means. In a nutshell, the lower your debt to income ratio, the better it looks to lenders. A low debt to income ratio means you’ve got the capability to take on another bill. A high debt to income ratio means you’re overextended.
What is a Good Debt to Income Ratio?
Lenders will look at many factors when determining whether you’re ready to take on another loan. They’ll look at your credit score, of course. They’ll also factor in what your debts actually are. For instance, your revolving credit may be weighed differently than installment loans.
Your debt to income ratio does tell lenders a lot about your financial health. In general terms, here’s what your debt to income ratio means:
If your debt to income ratio is lower than 35%, lenders will be pleased.
That means you’re managing your finances well, and that your income is more than enough to pay an additional bill, as well as to save money.
If your debt to income ratio is between 36% and 49%, that’s not as good. Your income is high enough to sustain you, but there’s usually little money left over at the end of the month.
If your debt to income ratio is 50% or higher, it’s unlikely you’ll be considered for credit. Keep in mind that utilities, food and other expenses aren’t included, so the money you have left after paying your bills will go to everyday expenses.
Average American Household Debt
If you’re wondering where your debt to income ratio sits in comparison with other Americans, you may be surprised to discover the answer.
According to the Federal Reserve in 2017, the average American household carries just over $137,000 in debt. This includes credit cards, mortgages, student loans and more.
The average American income, according to the US Census Bureau, is just over $59,000. Doing the math, you’ll see that’s a debt to income ratio of 232%. In other words, most Americans are living well beyond their means.
Now, does that mean that every American household has a debt to income ratio of over 200%? Of course not. You may have no credit cards at all, or no mortgage payments while another individual has two mortgages and $100,000 in credit card debt.
Suffice to say, though, that if your debt to income ratio is above 35%, you’re not in the minority. Most Americans take on more debt than they can realistically afford to pay down.
Whether you’re calculating your debt to income ratio in the hopes of acquiring a new line of credit or just to improve your creditworthiness, it’s important that you take steps to bring your debt to income ratio down. You can’t always increase your income, but you can control the payments you make.
Avoid taking on more credit, and utilize the credit you do have responsibly. Don’t make big purchases which will decrease your available credit, and try to double up on payments where possible. Check your debt to income ratio every three months or so to gain a better picture of your financial health.
You can also check with the many other articles we have on debt and credit here on DebtReviews, including How to Repair Credit, Living Wage vs Actual Wage and more. You can find them all using the menus above. Our Credit Calculator may also help you get a better idea of where you stand financially.