Many financial gurus these days are talking about the possibilities and advantages of being debt-free. While it is fulfilling to reach that level, more often than not, people cannot live without debt. As they say, a little of something is all right, but too much is another story.
Managing your debt-to-income ratio to the lowest possible level is already a good accomplishment, and it definitely is a huge step towards attaining a debt-free life. If you have been accustomed to loans and credits, target a low debt-to-income ratio your goal for now. Zero debt will come naturally and gradually, in time.
Calculating Debt-to-Income Ratio
At any rate, debt load is the sum of your mortgages, student loans, credit card debts, and other personal borrowings, excluding housing debts. You should know your monthly debt payment, or at least a good estimate.
Once you know your debt load and your monthly debt payment, it is time to tally your income. Add up all your sources of income in a year, which is your disposable or gross income. Divide your total income by 12 (months) to get your monthly income.
Debt-to-Income Ratio = Monthly Debt / Gross Monthly Income
For example, if your gross monthly is $10,000 and your monthly debt is $2,000, then your debt-to-income ratio is 20%.
$2,000 / $10,000 = 20%
How much debt is enough or too much?
Unfortunately, there is now specific answer to this question. However, experts recommend maintaining 10% to 20% debt-to-income ratio. This range allows you some loan flexibility whenever you desperately need it. The closer you get to the maximum “acceptable” range at 20%, the less likely you get credit and the more likely you experience financial strain.
The 28/36 Rule
Another helpful rule about debt management is the 28/36 rule, which suggests that your monthly household debt service (excluding house loans) should not exceed 28% of your gross monthly income, and your total debt service (including house loan) should not exceed 36% of your gross monthly income.