As a borrower, one area that a lender will look at more closely than just about any other is your debt ratio. It’s important to understand how your debt ratio is calculated and to be aware of what your current debt ratio is, especially if you plan on applying for any type of financing in the future.

The debt ratio, or debt-to-income ratio, is a measure that demonstrates how much of an individual’s monthly income is necessary to make payments on all of his or her debt obligations. For example, if your debt ratio is 50%, it means that it takes half of your income to make at least a minimum payment on all borrowed funds. These funds typically include mortgage debt, credit card debt, student loans, auto loans, and any other type of secured or unsecured debt that requires a borrower to make regular payments.

Earlier in this decade, lenders weren’t too concerned with debt ratios on most loans related to mortgages. It was an easy time to get financing, even if you didn’t have great credit or a low debt ratio. However, in a tight credit market like today’s, lenders are being much more careful in who they lend money to.

To determine your personal debt ratio, make a list of all of your outstanding debt and the minimum payment required to stay current each month. Total that number and then divide the total into your gross monthly income. It’s a simple calculation, but one that is important if you’re considering applying for a loan or refinancing while rates are low. A lender needs to be confident that a borrower will have the means to repay a loan, so they will avoid borrowers burdened with a high debt ratio.

There are only two ways to change your debt ratio. You can either increase your income or reduce your debt. Neither option is easy, but both are possible. To increase your income, consider finding a source of income to supplement your monthly paycheck. To decrease your debt, set goals to pay down balances as quickly as possible. If you are close to paying off a car, consider increasing your efforts to finish those payments early to eliminate one of your monthly obligations.

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Tags: debt ratio, financing, loan

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