How to calculate your debt-to-income ratio
How to calculate your debt-to-income ratio Many prospective homeowners or parents who want to help their child buy their first home are likely asking how they can do that themselves. It’s a crucial indicator for analyzing your financial health, as banks and financial institutions consider it before agreeing to a loan. Let’s dive in!
What is the debt-to-income ratio?
A debt-to-income ration—also known as the “debt ratio” or “debt-to-equity ratio”—is a calculation comparing your income against your debt. It helps lenders estimate your ability to repay a loan by seeing how much income is left over after paying your taxes, social security contributions and debts.[1]
Unlike your credit score, which is a snapshot of your credit history on a scale of 300 to 900, your debt ratio takes into account your current income and is expressed as a percentage.
How to calculate your debt-to-income ratio
You calculate your debt-to-income ratio by adding up all your regular payments and dividing the total by your gross monthly income. The expenses to look at are:[2]
- Rent or mortgage
- Car loan
- Student loan
- Credit cards
- Taxes
On the other hand, regular expenses like food, phone bills, electricity and transportation don’t factor in when calculating your debt-to-income ratio.
As for the income part it includes your salary, investment income, support payments (for you or a child) and any government benefits you’re receiving.[3]
The Government of Canada has a chart you can use to easily calculate your debt-to-income ratio. Feel free to use it so you can get a clearer idea of your situation.
What is a good debt-to-income ratio?
Ideally, your ratio should be as low as possible. Below 30% is excellent and puts you in a good position for loans from banks and financial institutions.[4] This ratio shows that you’re properly managing your day-to-day expenses and paying off your debts.
A ratio between 30% and 36% is good. However, a ratio of 40% or higher means more risk for lenders.[5] As a result, it might be hard to get a mortgage or repay one. In short, a high debt ratio is a red flag, meaning your debts take up too much of your personal finances.
You’ll inevitably have to calculate your debt-to-income ratio, whether you’re looking for real estate for yourself or as a guarantor of your child’s mortgage. Applying for a new loan or becoming jointly liable for someone else’s loan will impact your finances, so it’s worth thinking about!
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See also:
How to buy a home on a low income