When you apply for a credit card or when you apply for a loan, the lenders look at your debt-to-income ratio. This is a major factor in your credit score. If you are currently struggling with debt and considering bankruptcy, your debt-to-income ratio is an important consideration.
The Consumer Financial Protection Bureau describes your debt-to-income ratio as your ability to manage monthly payments to repay your debt.
How to calculate the debt-to-income ratio
If you want to calculate your debt-to-income ratio, you start with your gross monthly income. Your gross monthly income is the money that you earn before paying your taxes. Then, add up all your monthly debt payments. Include your rent or mortgage, your car payment, credit card payments and more. Then, divide your monthly debt by your income. The dividend is your debt-to-income ratio. For example, if your monthly income is $5,000 and your monthly debt is $3,000 then your debt-to-income ratio is 60%.
Why the debt-to-income ratio matters
Studies show that if you have a higher debt-to-income ratio, you may be unable to pay back your debt. Every month, you have to split your income into several different directions. Any unexpected cost could make it difficult for you to make monthly payments on your debt. A debt-to-income ratio can be high enough that a person has to choose between the debt and the necessities.
If you have a ratio of over 43%, you may not qualify for mortgages. This is a high debt-to-income ratio.
When filing for bankruptcy, a high debt-to-income ratio may indicate that bankruptcy is a smart decision.
