Monday, March 7, 2011

Calculating your debt service ratio

With all the talk about debt thats been in the news lately, you may be tempted to see where you stand financially, especially with the looming threat of increasing interest rates.

An easy way to do this is by calculating your debt-service ratio, the same calculation that banks use to determine whether you're a prime candidate for a mortgage. Simply calculate all your monthly debt payments, including your mortgage, minimum credit card payments, car loans, student loans, leases and any other form of loan. Next, calculate your gross monthly household income. Divide your debts by your income, multiply by 100 and that's your debt service ratio. To be in a healthy range, that number should be under 40 or, better yet, 35.

Some people find it more accurate to use their net income, rather than their gross income, for their personal debt service ratio calculation. Since you don't really have access to their full gross income, net income is a little more helpful in determining what percentage of your take-home income you're actually spending.

With interest rates expected to go up, you may want to fiddle around with the numbers, particularly higher mortgage payments. If you're set on sticking with a variable rate mortgage, experiment with different interest rates to see how high they can climb before you start to feel uncomfortable. While you're at it, see what your financial state would be if you locked in to a fixed rate today.

If you're already on the high end of the debt service ratio, you may want to consider trimming down your other debts, or uncovering ways to bring in extra income, to prepare for the upcoming increases.

-Axiom Mortgage Partners

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