While being debt-free is preferable, sometimes debt cannot be avoided. It’s useful to know how bad your current debt situation is to make improvements or to avoid making the same mistakes again.
A common ratio which is used to measure a person’s indebtedness is the debt-to-income ratio. Many of the financial institutions also use it when assessing loan applications.
In simple terms, your debt-to-income ratio is a representation of how much of your income goes towards servicing your debt. The higher this value, the worse it is for your finances.
How to calculate your debt to income ratio
- Add up all your monthly debt repayments. That’s everything you are paying towards a loan – home loans, vehicle finance, student loans, store accounts, credit cards, personal loans, etc. Do not include any additional contributions you may be making, just the minimum amount you need to pay.
- Divide this amount by the amount of money you receive in your bank account each month (salary, rental income, side hustles, etc.).
- Multiply the result by 100 to express your debt to income ratio as a percentage.
For example, if someone who earns R25,000 a month, has a home loan instalment of R7,500, vehicle finance R3,600 and a credit card minimum repayment amount of R730 every month, they could calculate their debt to income ratio as follows:
What does this number mean?
A value higher than 30%, as in the example above, is considered high. If the value is below 30%, it doesn’t mean you should stop and rest – remember any money that is being swallowed up by debt is money that is unavailable for you to invest, save or spend as you wish.
Wealthy Maths blog
Our friend Stealthy Wealth knows his way around maths. Luckily for us he also speaks human, which is why we asked him to explain the most important maths we need to know to be good at money. This is not your average maths class. Tune in once a month and turn into a money mathemagician.