How to Configure Debt Ratio
The debt ratio is a simple percentage used to determine the level of debt a person has compared with the level of income. This number is expressed as a ratio or a percentage. Banks generally use the percentage when figuring a debt ratio for an individual applying for a loan.
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Things You'll Need
- Income statements
- Debt account statements
- Calculator
- Accounting software
Instructions
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1
Using your calculator, add all of your pre-tax monthly income, including interest on savings, retirement, Social Security and work-related income. Write your total on the paper. For purposes of this example, the total income is $3,000.
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2
Add all of your monthly debt payments. Include debts such as car loans or leases, personal loans, mortgage, mortgage taxes and insurance, credit cards and medical bills. Do not include monthly bills, such as utilities, health insurance, entertainment or food. Write this total on paper. In this example, the total debt payment is $500.
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Enter your total monthly debt payments into the calculator.
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Push the divide button on your calculator.
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Enter the total monthly pre-tax income into the calculator.
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Push the "total" or "equals" button on the calculator.
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Look at the quotient, or answer, on the calculator. For this example, with income of $3,000 and debt of $500, the quotient reads 0.1666666667.
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Write this number down, rounding the second number after the decimal point if needed. For example, write down 0.17.
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Move the decimal point to the right 2 spaces to find the percentage. In this example, the debt ratio is 17 percent.
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Tips & Warnings
Banks generally do not like to see a debt ratio higher than 36 percent to 42 percent meaning that no more than this percentage is tied up in debt payments each month. Guidelines vary by lender.
When considering whether to offer a loan, a bank will only offer an amount up to the available percentage. For example, if you currently have 25 percent of your income tied up in debt, you will only be able to obtain a mortgage with monthly payments of 11 percent to 17 percent of your income, based upon the debt ratio figures.
If your debt ratio is higher than 20 percent and you want to obtain a mortgage or other large loan, you should first pay off debt to reduce your ratio to less than 10 percent.
An organization's debt ratio is found by dividing the total liabilities by the total assets. The number is usually expressed with a decimal point. For example, a business with 30 percent of its operations financed by debt and the remaining 70 percent by equity would have a debt ratio of 0.3.
