The Low Down on Debt to Income Ratios


While banks and the financial community in general may be quick to tell you that your debt ratio is fine and you can take on more or buy that house you’ve been yearning for, you shouldn’t be so quick to believe them. 

Plainly put, they want your business. And there’s often a lot more to your existing debt load, they are not aware of and that’s not factored into that ratio.

Your debt to income ratio is calculated by dividing your monthly expenses by your monthly income and the result tells you how much of your money is going out.

The remainder is supposed to be how much of that you can still spend.  And, some will say that as long as the ratio is in the range of 30%, you’re good to go. But here’s the clincher – it may not be a true picture or ratio.

First, not all your usual expenses have been included into the calculation and second, a debt to income ratio of 35% is actually too high.  It leaves no room or small buffer for things that can go wrong, like unexpected vehicle repairs, increased medications or illness. Nor does it factor in things like money for clothing, increases in heating or cooling costs or gift expense. It doesn’t even take into account usual increases in inflation.

A lower debt ratio is just safer. And understand that there’s still risk, regardless of how low your ratio is.  Life happens and there are often increases in monthly expenses or loss of revenue that you cannot predict. But a lower ratio may provide room to breathe and that in itself, can be a big relief.

Common expenses factored into a debt ratio are usually things like car loans, repayment amounts on lines of credit or credit card debt, rents or mortgages and large utilities.  Some do include average food costs, but there’s a lot more to consider when it comes to month-to-month living expenses.

To be prudent, you should be doing your own debt to ratio calculation and make sure you include all your usual monthly expenses.  This may be a good time to review your monthly budget and see exactly where your money is going.

What Should be Included in Your Debt to Income Ratio:

  • Rent or mortgage
  • Vehicle loan payments
  • Credit card or line of credit payments
  • Average medication costs
  • Average cost of food, groceries
  • Average cost of gas
  • Average cost of essential dietary needs (allergies) and personal care such as diapers
  • Average costs of energy, cooling and heating, water, sewer
  • Insurances – auto, home, health, life, accident
  • Other utilities: Phone, cell, internet
  • Sports and activities – priority costs
  • Student costs, bus passes, college fees
  • Retirement fund

Some of these expenses not usually factored into the ratio, can take quite a bit of change out of the monthly budget and they should be counted. The idea is to count as expenses everything that’s not optional and must be paid. There’s always more expenses that are difficult to estimate and will pop up later. Some you can cut down to stretch your budget further. Considering a retirement fund or small amount for savings as monthly expenses is also a good plan.

Make sure to average expenses on a monthly basis and use your take-home-pay amounts and not gross income, as some tend to do. What you really want to include in expenses are things the bank doesn’t think to ask, such as if you have some unique costs, others may not have such as those for special needs, college expenses and high travel costs back and forth to work.

Remember to use the projected cost of your new home, vehicle or loan payment to get a realistic look at your monthly expenses and whether you’ll have enough income to meet those commitments going forward.

It’s a good idea to err on the up side of expenses and the down side of income, if you want to reduce your financial risk even further.  And if you’re thinking of adding a large long-term debt, consider waiting a few months to clear your credit cards or small loans, before borrowing.

When it comes to buying a house, you should also take into consideration essential upgrades that you’ll need to cover soon, as well as expected increases to maintenance costs, which may not have been factored into your debt ratio.

Now while a low debt ratio should be your goal, you might be able to justify adding more debt to an already strained ratio, due to a unique circumstance or event.  That does happen and can turn out fine, as long you’re willing to reduce other expenses or add to your income, to manage the increased debt load.

We can often tighten our budget belts for short periods, that’s not a problem for many. That’s how many family vacations are funded. However, when there’s too much long-term debt, it can become a financial nightmare.

Financial advisers are there to help you and are often a blessing. But, they’re not always impartial and let’s face it, you’re the most knowledgeable when it comes to expenses your family usually has. It’s best not to totally rely on their advice, but instead to get a second opinion – your own. Calculate your debt to income ratio to satisfy self and it will also help you both understand where the money goes.

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