Attachment 1 – Example of how to calculate Debt-to-Income Ratio
Attachment 2 – Calculate my Debt-to-Income Ratio Worksheet
Attachment 3 – Track my Daily Spending Worksheet
Attachment 4 – How to Save $1000 a year – from pennies a day!
Have you ever been declined for a loan? But you’ve made your payments on time and have never been delinquent?
Well maybe it had some thing to do with your Debt-to-Income Ratio? With my what, I hear you say!!
Lets take a look at Debt-to-Income Ratio:
Debt-to-Income Ratio is a very simple method that is used to calculate how much debt you have and then compare it against your take home income. For ease of calculation this is done by using your monthly debt payments and monthly take home income.
One debt that is not part of the calculation is your rent or mortgage payment.
Now this is the million-dollar question J it is not as straightforward as it may seem, but bear with us and we will take you through it – step by step.
You may want to use attachments 1 and 2 for your ease.
Lets do this in 3 steps:
Step 1 – Calculate your take home monthly income
This is the amount that you take home after all your taxes and deductions have been made.
This income can come from all your sources of income, some examples are given below:
Your job(s)
Commissions
Bonuses
Pensions
Alimony
Interest on money
Child support
Social security
Tips
And any other income sources
Get the picture? So, now you have where your income comes from, how do we calculate into the monthly amount that is needed to calculate Debt-to-Income?
If you are paid each week, then multiply your take home income by 52, then divide by 12, this will give you your take home monthly income.
If you are paid every other week, then multiply your take home income by 26, then divide by 12, this will give you your take home monthly income.
If you are paid once each month, then you have your take home monthly income.
If you are paid a wage/salary plus commissions/bonus/tips that change each week/month, then you need to take an average for the last 12 months and this will give you what your estimated take home monthly income will be.
OK, that’s step 1 completed, lets move onto Step 2
Step 2 – Calculate your Monthly Debt Payments
In order to do this, gather up all your information regarding your debts, some examples of what you need to include are detailed below:
Auto loans
Credit Card payments
Medical bills
Dental bills
Bank loans
Student loans
Furniture loans
Any other debt payments
DO NOT INCLUDE the following in this calculation:
Mortgage
Rent
Utilities
Taxes
So, now you have your monthly debt payment, we can do the calculation which will give you your Debt-to-Income Ratio
Step 3 – Calculating my Debt-to-Income Ratio
Divide your total monthly debt payments (step 2) by your total take home monthly income (step 1); the remaining figure is your Debt-to-Income Ratio.
Example:
Also refer to attachment 1
Step 2 - Total Monthly Debt Payment is $950
Step 1 - Total Take Home Monthly Income is $2000
Step 3 - Divide your Total Monthly Debt Payment of $950, by your total take home monthly income of $2000, gives you a figure of 47.
Your Debt-to-Income Ratio is 47%
One of the things that creditors look at when reviewing your application, is your Debt-to-Income Ratio, even if you have a good payment history, your Debt-to-Income Ratio may be too high for them to grant you any additional credit.
Lets take a look at what they may follow when granting credit:
Debt-to-Income Ratio less than 10%
This is the best range for obtaining credit, you show that you have a low level of debt and are in good financial shape.
Debt-to-Income Ratio is between 11% and 20%
This is still a good range to be in for obtaining credit; you are still demonstrating that you are in control of your debt and financial situation. However, you should avoid taking on new debt payments.
Debt-to-Income Ratio is between 21% and 35%
You have now entered the questionable range with creditors, some creditors may take a more inquisitive look at your actual income and the debts you already have. They may even request more information and supporting documents before proceeding.
Debt-to-Income Ratio above 35%
You are now considered a high risk and your chances of obtaining further credit are doubtful.
Don’t forget: you may have an excellent Debt-to-Income Ratio, but if your payment history is poor you may still not get approved.
To find out what your Debt-to-Income Ratio is, complete the “Calculate my Debt-to-Income Ration Worksheet” – go to attachment 2.
Well, that is a simple question to answer, here is what you need to do:
Increase your monthly take home pay
Decrease your monthly debt payment/s
But it is not always that easy to do, is it?
Using “ track my daily spending worksheet” attachment 3 at the end of this newsletter, allows you to track what your family spends each and every day for a month. Give each member of your family, including the kids, a copy and get them to write down each time they spend money – even if it’s just for a packet of gum – you’ll be amazed at where the pennies went JJ
The savings you can make from this, will help increase how much available money you have each month and this can be used towards paying of your debt – thus helping to reduce your Debt-to-Income Ratio.
“How to save $1000 year - from pennies a day” attachment 4, gives you more great tips on where and how to save those pennies.
Why should I monitor my Debt-to-Income Ratio? I hear you ask.
Well, if you don’t monitor your Debt-to-Income Ration:
How will you know what your %?
How can you achieve you financial goals?
How do you know whether you stand a good chance of obtaining the mortgage you want?
How do ensure that your spending plan is still appropriate for your needs?
So you see, it is kind of important to do that.
This is a rule that mortgage lenders may use when reviewing your application.
The calculation is based on a 28%/36% rule from your gross annual income, gross annual income being the amount before you pay taxes.
Not more than 28% of your gross (before taxes) monthly income should be spent on your mortgage payment, taxes, insurance, mortgage insurance and homeowner dues.
Example:
Gross (before taxes) annual income is $60,000
Divide this my 12 to obtain your gross monthly income = $5,000
Take 28% of your monthly income = $1,400
Therefore, your monthly mortgage payment should not be more than $1,400 of your monthly income.
Payments, including mortgage, taxes, insurance, mortgage insurance, home owner dues plus all other debts, including: student loans, credit cards, auto loans, furniture loans etc, should not exceed 36% of your gross monthly income.
Example:
Gross (before taxes) annual income is $60,000
Divide this by 12 to obtain your gross monthly income = $5,000
Take 36% of your monthly income = $1,800
Therefore, your monthly mortgage payment, plus all other debts under the 36% rule should not exceed $1,800 of your $5,000 gross monthly income.
This is another method that lenders can use when reviewing credit applications.
Like the 28/36 rule, the calculation is also based on a % of income and debt. However, using your net take home pay, which is your income after you have paid taxes and deductions, does this.
Lets have a look:
Your total annual debt (excluding your mortgage) should not exceed 20% of your net annual take home income (money left after paying your taxes and deductions).
Example:
Net annual take home income is $42,000
Take 20% of your annual net take home income = $8,400
Therefore, your total debt (excluding your mortgage) using the 20% rule, should not exceed $8,400
Your total monthly debt payment (excluding your mortgage) should not exceed 10% of your net take home income.
Example:
Net annual take home income is $42,000
Divide this by 12 to obtain your net monthly take home income = $3,500
Take 10% of your monthly income = $350
Therefore, your total monthly debt payment (excluding your mortgage payment), using the 10% rule, should not exceed $350 per month.
Example of how to calculate Debt to Income Ratio
Step 1 – Calculate your monthly take-home pay.
Step 2 – Calculate your total monthly debt payments – excluding your rent or mortgage payment.
Step 3 – Divide your total monthly debt payments by your total monthly take home pay.
Step 1: Calculate your monthly take home pay:
|
Monthly Income |
$ |
|
Monthly take home pay |
$1700 |
|
Tax Refunds |
$ |
|
Dividends or interest |
$ |
|
Other income subsidies |
$ |
|
Bonuses, commissions, or tips |
$ |
|
Full- or part-time employment income |
$ |
|
Child support or alimony received |
$300 |
|
Pension or other retirement income |
$ |
|
Welfare or other government entitlement programs |
$ |
|
|
$ |
|
My Total Monthly Income: |
$2000 |
Step 2: Calculate your total monthly debt payments:
|
Monthly Debt |
$ |
|
Car payment(s) |
$240 |
|
Loan payment(s) (furniture, appliances, etc.) |
$60 |
|
Financial institution loan(s) |
$ |
|
Student loan payment(s) |
$100 |
|
Other loans/credit accounts |
$ |
|
Credit card payments |
$550 |
|
Payment for past medical care |
$ |
|
|
|
|
My Total Monthly Debt: |
$950 |
Step 3: To calculate your Debt-to-Income Ratio:
|
Divide your total monthly debt payments (step 2) by your total monthly take home pay (step 1) $950 divided by $2000 = 47 |
|
|
My Debt to income ratio is: |
47% |
Debt-to-Income Ratio should be below 20%
Calculate my Debt to Income Ratio Worksheet
Step 1 – Calculate your monthly take-home pay.
Step 2 – Calculate your total monthly debt payments – excluding your rent or mortgage payment.
Step 3 – Divide your total monthly debt payments by your total monthly take home pay.
Step 1: Calculate your monthly take home pay:
|
Monthly Income |
$ |
|
Monthly take home pay |
$ |
|
Tax Refunds |
$ |
|
Dividends or interest |
$ |
|
Other income subsidies |
$ |
|
Bonuses, commissions, or tips |
$ |
|
Full- or part-time employment income |
$ |
|
Child support or alimony received |
$ |
|
Pension or other retirement income |
$ |
|
Welfare or other government entitlement programs |
$ |
|
|
$ |
|
My Total Monthly Income: |
$ |
Step 2: Calculate your total monthly debt payments:
|
Monthly Debt |
$ |
|
Car payment(s) |
$ |
|
Loan payment(s) (furniture, appliances, etc.) |
$ |
|
Financial institution loan(s) |
$ |
|
Student loan payment(s) |
$ |
|
Other loans/credit accounts |
$ |
|
Credit card payments |
$ |
|
Payment for past medical care |
$ |
|
|
|
|
My Total Monthly Debt: |
$ |
Step 3: To calculate your Debt-to-Income Ratio:
|
Divide your total monthly debt payments (step 2) by your total monthly take home pay (step 1)
(Step 2 total)$____________divided by (step 1 total) $____________ = _______
|
|
|
My Debt to income ratio is: |
% |
Debt-to-Income Ratio should be below 20%
Track my Daily Spending
Each day, write down what you spend for EVERY purchase you make – no matter how small J
Use a new sheet for each day or for repetitive purchases each day just the same sheet.
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Where I spent my money: |
Mon |
Tues |
Wed |
Thu |
Fri |
Sat |
Sun |
Total |
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Total for this sheet |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
|
Combined totals from all my sheets for this week |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
My total spending for this week is $________________________
How to save from pennies a day
Here are some classic examples of how people waste money on a daily basis and don’t seem to be aware of what they are doing.
The Daily Soda
-
1 can of soda = $1.25
2 cans of soda per day x 5 days per week = $12.50
2 cans of soda per day x 5 days per week x 50 workweeks = $625.00
The Donut and Coffee or Mac Muffin Breakfas
-
1 donut and coffee or Mac Muffin a day = $3.00
1 donut and coffee or Mac Muffin a day x 5 days per week = $15.00
1 donut and coffee or Mac Muffin a day x 5 days per week x 50 workweeks = $750.00
The take-out Big Mac or KFC Lunch
1 take-out lunch a day = $6.00
1 take-out lunch a day x 5 days per week = $30.00
1 take-out lunch a day x 5 days per week x 50 workweeks = $1,500.00