How To Calculate Debt Management Ratio In Finance

When talking about debt management, there is an important ratio that you will learn about throughout this article. This ratio comes from two parts and it helps determine if your credit card spending has become too profuse. You can read more about it here.

You are probably very familiar with this ratio when it comes up in conversations surrounding credit cards. It is referred to as the Debt-To-Credit Card Income Ratio or DCI for short.

This ratio looks at how much money you spend compared to what income you have coming in. If you find yourself with less cash than bills, then this ratio becomes increasingly significant because it determines whether or not you can keep paying those bills.

If you need to take time off work due to health issues, or you lose your job, your chances of being able to pay your debts diminishes rapidly. Therefore, it is important to understand how to calculate debt management ratio now.

How to Calculate Your Debt Management Ratio

The DCI ratio works by taking all of your monthly financial obligations (credit cards, mortgage, student loans, etc.) and dividing them by your gross monthly income. The resulting number is your debt management ratio.

A higher debt management ratio means you are spending more money per paycheck on things that do not add value to your life. For example, buying a new smartphone every month or going into huge amounts of debt so you can afford to live away from home would be investments in your future.

Calculating debt service balance

how to calculate debt management ratio in finance

The second way to calculate your debt management ratio is by calculating what you refer to as the debt service balance. This can be done using the equation: Total monthly payments - Savings per month x Number of months until payment date.

The total monthly payments are simply adding up all of your current loans, credit cards, loan repayments and such like. These should include any additional monthly fees for the loan (for example if you have a mortgage, you would add the house rent to this).

Your savings per month is just how much money you manage to save each day so that you have enough left over at the end of the month. This can vary depending on whether you are spending more than usual or if you’re finding it difficult to save due to lack of income.

Number of months until payment date is clearly dependent on when your next payment is due which we discussed earlier.

Calculating current debt

how to calculate debt management ratio in finance

The current debt level is calculated by adding up all of your monthly loan payments, credit card balances, investment loans, etc. This includes interest that has already been paid but not including any possible new fees or additional charges for late payment!

This does not include what you have put into savings or other investments. These are adjusted out when calculating the debt-to-income ratio.

By using these two different ratios, we can get an idea of how well you manage your money. If you find yourself with a high debt management ratio, it may be time to make changes.

Hopefully this article gave you some tips on how to calculate your debt-to-income ratio.

Calculating long term debt

how to calculate debt management ratio in finance

The second way to calculate your LTV is by calculating how much longer it would take to pay off your debts if you made no more credit card purchases. This is known as the length of time needed for repayment, or what we refer to as the duration of loan payments.

By adding up all of the monthly payment amounts that go into paying off each creditor, you can determine how many years it will take to clear your credit cards!

This calculation takes into account both lower interest rate loans and lower minimum payment amount loans, so even though you may owe less money at the end of every month, you could spend several months making large payments before clearing everything up.

It also does not factor in any possible rewards programs that some creditors offer, but instead calculates only the cost of the loan.

Calculating short term debt

how to calculate debt management ratio in finance

The way to calculate your short-term debt ratio is to take all of your debts (credit cards, loans, etc.) and add up how much you have spent in the past month. Then divide that number by how much money you have in the bank or credit card accounts to get your monthly spending amount.

You can then subtract this value from what you made during the same time period to find your net income for the month. Once done, divide the total net income by the length of the month to determine your short term debt ratio.

Your short term debt ratio should be below 20% per these calculations.

The reason why it’s important to look at both long and short term debt is because longer term obligations have more weight than shorter ones when calculating whether or not you are able to pay off your debts.

Longer term debts like house payments and student loan repayments will have a bigger impact on your finances than say, taking out a $1,000 cash advance every two weeks.

Calculating interest

how to calculate debt management ratio in finance

The second way to calculate debt management ratio is by calculating how much money you need to pay in monthly bills to have a steady income. You can use this information as a yardstick to determine if your credit card balance is within control or not.

By having a stable source of income, it helps prevent large swings in spending that could potentially put more pressure on your budget. It also gives you time to reevaluate your lifestyle choices because you know what level of spending you will be able to afford.

You can compare these two numbers to see whether you are providing enough protection for yourself.

Calculating principal

how to calculate debt management ratio in finance

The main (or principal) debt of your credit card is typically referred to as interest payments. This includes all of those monthly finance charges you pay for direct debit, recurring online purchases, etc.

The total amount of this payment varies per creditor but it’s usually an annualized cost that’s calculated by multiplying the average daily balance by the length of time spent at high-interest rate times one adjusted for the prime lending period.

This number is then divided by 12 to get the yearly cost. Most lenders use a 180 day year which would make the ratio 365 days / 12 months = 3.25.

By looking at our example above, his main debt comes out to be $1,837.50 every year! That’s over $5k per year just because of how much he spends on plastic. You can see how easy it is to rack up expensive debts if you don’t watch yourself.

General recommendations are to try and reduce your spending to below what you spend now so that you can lower these costs. However, there are other ways to manage your money when it comes to debt.

Calculating liquidity

One of the most important things to consider when calculating your debt management ratio is how much money you have to pay debts. Obviously, if you have no money left every month to spend, then this calculation makes little sense.

Most experts agree that having a large amount of monthly income is more important than having a very low debt payment. This is because it gives you freedom to do other things with your life. You can go out with friends more or invest in new hobbies.

If you have enough money each month to make these commitments, then avoiding bankruptcy is always the better choice. In fact, most people who file for Chapter 13 bankruptcy are able to keep their house free of credit card debt!

By paying off all of their high interest credit cards ahead of time, they are able to use those funds to start rebuilding their lives.

Calculating debt service cover

how to calculate debt management ratio in finance

The term *debt service coverage* is typically defined as your monthly income divided by your monthly loan payments. However, you can also use this ratio to determine how much of a cushion you have against bankruptcy if you reach financial crisis.

This concept was first discussed in our article about ways to prove creditworthiness, but it makes more sense to reword the equation here. Your debt service coverage should be equal to or greater than two!

That means that every month you must make at least twice your monthly loans in payment obligations. For example, let’s say you have a $1,000 car loan with a monthly payment of $200 and your job pays you an extra $300 per week ($4,800 per year). You would need to pay at least $800 per month (2 x $4,800) to satisfy the requirement for debt service coverage.

If you made only $400 per month after paying off your loan, your debt service coverage would be less than 2! This could put you in risk of bankruptcy due to not being able to afford to repay your debts.

I know what you are thinking – why wouldn’t I just spend whatever money I have left over from my budget on repaying my debt? While this may seem like a good short-term solution, it will cost you far more in the long run.

By taking care of your debts, you set yourself up for success financially.

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