How Does the Debt-to-Income Ratio Affect My Financial Situation?

The debt-to-income ratio is a very telling method of looking at your financial situation. It is a good way to determine whether or not you have any money left over after you pay all of your expenses and debt obligations. The best and most complete way to look at your debt-to-income ratio is over the period of a month.

The amount of debt that you have compared to your income is the debt-to-income ratio. So if you pay $1000 in expenses each month, but you earn $2000 a month, your debt to income ratio is 1:2, or $1 of expenses to every $2 of income. If it was the other way around ($2 in expenses for every $1 of income) you know you're in trouble!

Looking at the ratio, or the percentage in this way helps you see your financial situation in a complete picture. Here's a break down of the ratio here so you can better see how it works and affects you:

Financial experts will tell you that your monthly debt should be less than 36% of your total income. So if you bring home $3,000 a month, the total of your monthly debts should not be more than $1,080.This means you have enough money to save for emergencies and retirement.

To further break down the suggested financial situation, experts will then tell you of the$1,080 in expenses per month, 28% should be the limit for your housing expense, so in this example – up to $840 a month. Housing expenses include rent, renter’s insurance, or your mortgage, home insurance and taxes. You can probably tell why most people don't follow this rule for their monthly housing cost limits!

The remaining 8% of your income, in this case, $240, is supposed to be enough for all of the rest of your monthly expenses. This includes utilities, car payments, groceries, etc.

For most families, this is not how the financial situation works in reality. Most households exceed the 36% by a LOT. This is where the saying "living paycheck to paycheck" has come from, and why people tend to make just the minimum payments on their credit card bills each month. It's also why there are many months when families haven't set any money aside for emergencies, savings, or retirement plans.

Does your debt-to-income ratio help you see your financial picture now? Using this information, you can create a plan to reduce your monthly expenses and/or increase your income. This will help you get your debt-to-income ratio into the targeted range and improve your financial outlook. Here are some tips:

Concentrate on variable expenses: One of the easier methods for reducing expenses is to concentrate on the ones that are variable each month. Things like groceries, gasoline, utilities have different costs each month. You can use strategies like coupons for groceries, adjusting the heating and cooling temperatures, or traveling less to decrease these variable costs.

Cut back on fixed expenses:Once you've done all you can to reduce your variable expenses, focus on your fixed expenses. Use balance transfer credit cards with no or low interest rates to save money on your credit card bills. Lower insurance premiums by raising deductibles. Cancel unnecessary subscriptions and memberships. Cancel cable or reduce the number of channels you have.