Maintaining a healthy debt-to-income ratio is important in financial planning because it helps you understand how much debt you can reasonably afford based on your income. A debt-to-income ratio is the percentage of your monthly income that goes towards debt payments, including mortgage, car loans, credit card debt, and other debts. A high debt-to-income ratio can indicate that you are spending too much on debt payments and may be at risk of financial instability if an unexpected expense arises.
Let us understand this with the help of an illustration:
Riya, a 30-year-old professional working in Mumbai, earns a monthly income of ₹60,000. She has various financial liabilities, including a home loan, a car loan, and credit card debt.
– Home Loan EMI: ₹20,000 per month
– Car Loan EMI: ₹8,000 per month
– Credit Card Debt: ₹5,000 per month (minimum payment)
Her total debt payments per month sum up to ₹33,000.
To calculate her debt-to-income ratio:
Debt-to-Income Ratio = (Total Monthly Debt Payments / Monthly Income) * 100
So, for Riya:
Debt-to-Income Ratio = (₹33,000 / ₹60,000) * 100 ≈ 55%
To improve her debt-to-income ratio, Riya can take several steps:
1. Increase her Income: Riya can explore opportunities for career advancement or consider taking up freelance projects to supplement her income.
2. Pay down Debt: Riya should prioritize paying off her high-interest debts first, such as credit card debt. By allocating more funds towards debt repayment, she can reduce her overall debt burden and improve her debt-to-income ratio over time.
By implementing these strategies, Riya can work towards achieving a healthier debt-to-income ratio, which is essential for long-term financial well-being and stability.
Riya’s debt-to-income ratio is 55%, which is higher than the recommended threshold of 30%. This indicates that a significant portion of her income is going towards debt payments, leaving her with less disposable income and potentially making her financially vulnerable in case of unexpected expenses or emergencies.
It is not universal rule but anything below 30% is considered as good debt to income ratio.