debt ratios

Debt Ratios Can Help You Spot Financial Trouble Before It’s Too Late

Lenders use debt ratios such as the payment-to-income ratio (PTI) and the debt-to-income ratio (DTI) to help them analyze credit risk before making a loan. However, you too can use such debt ratios. First, you can use debt ratios to see how much of a mortgage loan you may be able to afford, for example. But you can also use debt ratios to spot financial trouble before it’s too late.

Excessive debt can be very difficult to deal with, so it’s important to recognize a brewing problem and address it before it gets out of control.

Debt Ratio Calculator:

Pretax Monthly Income








Monthly Debt Payments










Instructions:

Change the inputs in the fields above and click “Calculate” to get your resulting debt ratios.

Pretax Monthly Income

These fields represent your recurring earnings and other income that you reasonably expect to continue going forward. Other income can include a pension, rents, interest, and dividends, for example.

Make sure to enter the monthly average for each income category.

Gross Wages:

Enter the monthly gross wages before any deductions for taxes or other items. So if you make an annual salary of $60,000, for example, you would enter $5,000 ($60,000/12 months). Alternatively, if you earn a gross pay of $800 per week, enter $3,200 ($800 x 4 weeks per month).

If your earnings vary or are seasonal, one option would be to try to figure what you expect to make for the entire year, and divide by 12 months.

Div & Int:

Dividends and interest are recurring types of investment income. Bank interest is usually paid monthly. But dividends on stocks are generally paid quarterly, and bond interest semi-annually. Mutual funds can pay dividends and interest monthly or quarterly.

Figure the expected annual recurring income and divide by 12 months. Do not include capital gains or capital gains distributions (from mutual funds) since these types of income are unpredictable and vary (not stable and recurring).

Net Bus Inc:

If you earn money from a sole proprietorship or partnership business as an owner enter this income here. The income entered should be the average net income per month. This means gross revenue less recurring business expenses. Because revenue may fluctuate and expenses are not always paid monthly, take the projected annual amount and divide by 12 months as necessary.

If you can’t estimate your income with confidence and/or it will be similar to the prior year, you can use the amounts on tax forms Schedule C (sole proprietorship) or K-1 (partnership). Just make sure to convert these annual numbers to monthly averages by dividing by 12.

Note that if your business operates as an S-corporation, you may also pay yourself wages. Enter the monthly average of any wages paid in “Gross Wages” above. Then enter your portion of the average monthly remaining profit in this field. This remaining income is also reported on a Schedule K-1 (similar to a partnership).

Net Rent Inc:

You may have a rental property which also generates income for you on a monthly basis. Enter in this field the net monthly rent by subtracting the monthly average of your expected recurring rent expenses from the gross monthly rent. Examples of such rental expenses include maintenance, mortgage payments, property taxes, etc.

If you own the property directly, this income is reported on Schedule E for income tax purposes. However, if you own the property through a partnership or LLC with more than one owner, then the income is reported on a Schedule K-1 tax form. These tax forms can be used to estimate the monthly income if you do not have access to more current records.

Pension Inc:

This can include Social Security Retirement Benefits, regular ongoing IRA or SEP account distributions, or defined benefit plan distributions from an employer pension. Enter the gross monthly pension amount before any tax deductions in this field.

Other Inc:

The monthly average of any other recurring income not entered above should be entered here.

Monthly Debt Payments

These fields represent your recurring monthly debt payments that you reasonably expect to continue going forward.

Make sure to enter the monthly average for each debt payment category.

Credit Card Min:

For credit cards and other debt payments below, only enter the minimum payment you are obligated to make on a monthly basis.

Auto Loan:

Any recurring auto loan or lease payments should be entered here. If you have more than one auto, combine the payments here and enter as one number.

Mortgage P&I:

Enter here the monthly payment you are required to make on your mortgage for principal and interest. If you escrow RE taxes and home insurance with the mortgage company, you can enter the entire payment which includes the monthly escrow amounts here. Then you can leave the next two fields blank.

RE Taxes:

Although real property taxes and (home insurance below) are not debt payments per se, they represent recurring expenses that a homeowner pays. As such, they are included in the debt ratios.

Home Ins:

As the final item in the PITI acronym, this field should include the average monthly cost of your homeowners insurance, plus any flood insurance.

Alimony/Child Sup:

Again, although not loan payments per se, these items are included in the DTI ratio when applicable and recurring since they are legally required to be paid.

Student Loan:

Include the monthly average of minimum mandatory student loan payments in this field.

Other Debt Pmts:

Any other recurring debt payments not covered above should be included here.

Payment-To-Income Ratio (PTI)

This ratio is also referred to as the housing expense ratio. It measures how much of the borrower’s recurring monthly income will be used up by monthly housing expenses. These expenses are generally the mortgage principal and interest, real estate taxes, and home insurance (PITI).

The PTI ratio is calculated by dividing the monthly PITI costs by the borrower’s gross recurring and stable monthly income.

Debt-To-Income Ratio (DTI)

The DTI ratio measures not only how much of the borrower’s gross recurring monthly income will be used up by monthly housing expenses (PITI), but also by any other recurring debt payments as well. These other payments can include credit cards, auto loans/leases, student loans, alimony/child support, and other recurring debt payments.

Payments on all such debt where at least ten or more payments remain are included in the ratio.

The DTI ratio is calculated by dividing the monthly debt payments of PITI plus consumer and other debt by the gross monthly income of the borrower(s).

Conclusion

Even if you are not shopping for a mortgage, it’s wise to figure your debt ratios once in a while. It especially pays to check debt ratios when there are changes in your financial situation. One example would be an increase or decrease in income due to a job change, promotion, or retirement. Another example would be a new loan or debt obligation, or the elimination of one.

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