How do you calculate the debt-to-income ratio?

Calculating the debt-to-income ratio is essential for understanding an individual's financial health, particularly in relation to their ability to manage monthly debt payments. The correct method involves summing total housing expenses, such as mortgage payments, property taxes, and homeowner's insurance, and then dividing that sum by the individual's gross monthly income. This ratio helps lenders assess the risk of extending credit; a lower ratio typically indicates better financial stability.

The focus on housing expenses is crucial because it reflects the primary financial obligation that many borrowers have. By contrasting these expenses against income, one can obtain a clear picture of how much of their earnings are consumed by housing costs. This calculation informs decisions regarding affordability and the potential for additional debt.

In contrast, other options do not provide an accurate measure of the debt-to-income ratio. Dividing total assets by total income does not address debts or cash flow. Calculating income minus total debts gives a snapshot of net income but fails to put it in the context of how much debt is owed compared to total income. Subtracting housing costs from gross income does not reflect the proportion of income that goes toward debt obligations, which is vital for the assessment of one's debt load.