Contrary to popular beliefs, there are two main things to consider when analyzing your own personal finances, and trying to figure out where exactly you are financially. Hint, your FICO score is not one of them. It’s your DTI. So your debt and your income are the two main factors and before you can figure anything out, you need to break down all of your income and all of your debts. The basic understanding we all have is that you need to have more money coming in than you have money going out. But that does not really show you the whole picture. This is why you need to look at your debt to income ratio to understand the entire financial puzzle. Your ratio can help you come up with calculations that will allow you to understand where you stand, and whether or not you can take out a loan for a home or a car, and how much the amount could be.
It is important to understand that financial ratios won’t give you all the details that you need but it does give you a start, and understanding them will put you on the right track. It is important to understand your net worth before getting into any complicated financial discussions. Your net worth is essentially the complete break down of your income and assets compared directly against what you owe. When you are in good standing you will have more assets than you will have debt and when you are in bad standing you have more liabilities than you do assets.
One of the best ways to establish which kind of standing you are in is to calculate your debt to income ratio. The formula is pretty easy as you are going to take all of your debt and minus it from the amount of income you have coming in. Some people say not to include your property and its taxes, but to get the complete picture you need to.
So how do we start adding everything up?
The easiest way to start is by adding up all your payments each month and this includes cars, insurance, credit cards, student loans, entertainment fees, and any other monthly payments. Now put this number to the side.
Next you need to add up all of your income by taking your salary, bonuses and outside income and add it all together. Make sure to break that number into separate money amounts. Now you are going to take your total debt number that you figured out before and divide it into your monthly income rate. That will give you the percentage that is your debt to income ratio.
So what is the importance of that number?
This is the number that banks will look at when evaluating you for a loan. So you can see that you want this number to be as low as possible as it will essentially show how well off you are financially.
When looking to purchase a home the bank is going to look at two different debt to income ratios. The first one is going to be the ratio that is included with all expenses including your mortgage and taxes. The second one is the back ratio that does not include the home and taxes. Lenders want these numbers to be at 36% and 28%, or less respectively.
Calculating these numbers yourself will allow you to understand what is going to happen if you are going to purchase a home when you approach the bank. If your numbers aren’t where they need to be then you need to start taking steps towards making it better. Of course the easiest thing that comes to mind is to try to earn more money but that is usually easier said than done.
One of the best ways to improve your ratio is to analyze all of your bills. Will you be able to cut money by spending less on items such as your cable or phone? That could be a great start. Next on the list you need to look at different insurance that you may be paying. Start comparison shopping in order to see if you can save money by switching insurance providers. The best one to start off with is your car insurance. On top of those two options, increasing the amount of money you save can be a huge help, as it can lower the cost of a mortgage by allowing you to place a larger down payment on a home.
The best part of getting this all down and in mind is that you can understand where you are financially. If you avoid calculation your debt to income ratio then it can be almost impossible to start a budget, save money, or realize where you stand. This easy calculation will allow you to understand what you need to change, which type of loans you may be eligible for, and allow you start breaking any bad habits that may be forcing you further and further into debt.