Unless your last name is Trump or you were recently the last “Survivor” in Somoa, you’ll probably need a mortgage to purchase a home. Not many folks can afford to pay cash for a more than $100,000 purchase. But to get a mortgage, you have to prove that you can actually pay it off. And that means your lender will be looking at something called DTI or debt to income ratio.

Fortunately, this little calculation is pretty darned simple. Let’s see if you can figure it out on your own with these questions:

1.  What is your debt?

2. What is your income?

3. What is a ratio?

Of course, there are many ways to describe your debt (housing, housing + other debts) and many ways to describe your income (gross yearly, take-home monthly). But ratio? That’s simple.

A ratio is a way to compare two numbers, either by using a colon or a fraction. In this case, we’re looking for a number, so we’ll write the debt to income ratio as a fraction and then divide. But how do you know which is the numerator and which is the denominator?

Turns out that’s pretty simple, too. Look at the order: debt comes first, so it will be in the numerator; income comes second, so it will be the denominator. If you think of “to” as the fraction bar (or as division), this makes sense.

debt to income =

[pmath size=12]debt/income[/pmath]

You can’t get much easier than division, especially if you can use a calculator. But in order to divide, you need to define your variables. In other words, you need to know what “debt” means and what “income” means.

In this situation, income is your monthly gross income. If you get a weekly paycheck, you’ll have to multiply that amount by four. If you paid twice each month, multiply by two. And if you get paid once each month, you don’t have to do a thing.

The debt can be calculated one of two ways. Some lenders only want to know what your expected housing debt is. This amount will include your monthly mortgage payment, insurance and taxes But these days, lenders are looking at your entire debt, which also includes monthly payments for child support, student loans, car loans  and minimum credit card payments — plus your expected housing debt. (You don’t need to include regular monthly bills like energy and childcare costs.)

Let’s say your monthly gross income is $3,027. You’ve figured out that you can afford an $890-per-month housing payment (to include mortgage, insurance and taxes). In addition, you have the following regular monthly debts: minimum monthly credit card payments ($35), student loan payments ($150) and car payment ($300). What is your debt-to-income ratio?

Method One: Simply divide your expected monthly housing expenses by your monthly gross income.

890 ÷ 3027 = 0.29

So using the first method, your debt-to-income ratio is 29%.

Method Two: Add all of your monthly debts and then divide by your gross income.

890 + 35 + 150 + 300 = 1375

1375 ÷ 3027 = 0.45

Looking at all of your monthly debt payments, your debt-to-income ratio is 45%.

But what does this mean? In short, these numbers spell danger. Anyone with a 40-49% DTI is not doing well financially. (Over 50% is considered “living dangerously.“) Most lenders like to see no more than 28% of your monthly debt going to housing costs (mortgage, insurance and taxes), and no more than 36% DTI over all.

If the above scenario were real, it’s very likely you would not be offered a mortgage. (And if you were, run in the other direction. You probably don’t want that kind of debt.) The goal, of course, is to get your DTI as close to 0% as possible. But anything below 28% for housing only and 36% for all debt is within reason.

What’s your DTI? Are you surprised by this amount? How can you reduce it? Feel free to respond in the comments section.

Photo courtesy of Robynlou8

Today, I’m guest posting at Tinfoil Tiara on the CantonRep.com.

It’s not likely that our nation’s poor math skills caused the housing crisis or the Great Recession, but it’s likely being confident in math can help you stay out of debt and put more money in the bank.

Every day, I meet people who tell me that they’re no good at math.   That’s an understandable sentiment, given the way math is taught. But the cold, hard truth is you have to do math.

Read the rest of my post here.

Today, I welcome Annie Logue, a terrific writer who specializes in business and economics. When she offered to write a guest post about the difference between good and bad debt (with a particular emphasis on student loans), I jumped at the opportunity. We decided that she would write the first half, and I would do the math at the end. If you have questions, she’ll come back and chime in.

Annie Logue

Economists recognize that debt can be good. It smoothes out consumption over a lifecycle, they say; if most people had to save up enough money to buy a house, for example, they would never be able to do it. By taking on mortgage payments while they are working, people can buy a house, live in it, and then pay it off before retirement so that they can live rent-free then. By taking on debt, people have the use of a house while they are paying for it and after it is paid for.

Good debt, then, lets you enjoy the benefits of something before, during, and after the time that you pay for it. It gives you a long-term economic benefit, such as a place to live for the rest of your life.

By contrast, if you run up your credit card to buy a new outfit for a fancy party that you only wear two or three times, and then make the minimum payment on your card, you have bad debt. You took on debt for something that you could enjoy for only a short time – not during or after the years it takes to pay it off. The faster you pay this off, the better!

Student loan debt is usually thought of as good debt: you borrow money to get an education, which is a good thing, and it increases your lifetime earnings power. You can enjoy real personal and economic benefits before, during, and after you pay the debt off.

However, with the rising price of college, the shift in funding toward student loans, and the ongoing recession, many people are asking if college is still enough of a benefit to make the debt worthwhile.

The short answer is yes; the long answer is yes, but.

Georgetown University’s Center on Education and the Workforce has done extensive work on this issue.  What they have found is that the degree matters; people with a bachelor’s degree, on average, make $2,268,000 over a lifetime, while those with a high-school diploma earn, on average, $1,304,000. However, occupation also matters, and many people earn more money than people who have a higher level of education. Someone with a Masters in English Literature is unlikely to earn as much over a lifetime as a police officer or a fire fighter.

We’ve seen the same thing in the housing market, by the way; people who borrowed what they could afford for houses that they intended to live in for a long time aren’t feeling especially pinched by the recent big drop in real estate prices. People who stretched and hoped to flip at a big profit have been suffering mightily.

It’s fine to borrow money for college, but those who do should be practical about it. They need to think about whether they are using that education to enter a field that is likely to make the debt pay off.

Doing the Math

What will a student loan cost in all? To assess whether even good debt will be a good idea, it can be helpful to consider the total cost of the loan and then compare that cost to the average total earnings over a lifetime. Here’s how that can be done.

Chloe is planning to attend a four-year public university. She estimates her tuition, plus room and board to be $15,000 each year. She received a $10,000 scholarship, which will be divided throughout the four years. If she takes out a federal student loan to cover the rest of the costs, how much will her college education cost in all?

First off, she needs to figure out the amount she will borrow each year. Her scholarship is $2,500 each year ($10,000 ÷ 4 = $2,500), which means the annual total that she will borrow is $15,000 – $2,500 or $12,500. She plans to complete her degree in four years, so the total that she’ll borrow is $12,500 • 4 or $50,000.

Remember, this amount is only the principal, or the amount Chloe will borrow. More complex calculations are necessary to find the total amount of the loan, which depends on the interest rate and her monthly payment.

Chloe’s interest rate is 6.8%, and she’d like to pay off her loan in 20 years. Using an online calculator, she finds that her total loan will cost $91,600.68, with a $381.67 monthly payment.

But 20 years sounds like a very long time. What would she need to pay each month in order to pay off her student loan in 15 years? The online calculator spits out $443.84. By paying the loan off earlier, her total cost is only $79,891.81.

So for an extra $62.17 ($443.84 – $381.67) each month, she can save a total of $11,708.87 ($91,600.68 – $79,891.81) in interest over the life of her loan! But even with the second option, she’ll pay a total of $79,891.81 – $50,000 or $29,891.81 in interest.

So how does Chloe’s total student loan debt compare to the amount of money she’ll earn over a lifetime? Let’s take a look. With a college degree, she can expect to earn a total of $2,268,000. If she pays off her student loan in 15 years, she’ll have paid a total of $79,981.81. What percent of her total expected earnings went to her loans?

$79,981.81 ÷ $2,268,000
0.035 or 3.5%

Not a bad return on investment. The trick of course is to get a decent job after graduation and stay on top of those monthly payments.

How about these scary statistics:

1. In the U.S. student loan debt is huge. Last year alone, students took out $117 billion in federal student loans. The Consumer Financial Protection Bureau estimates that the total U.S. debt has now exceeded $1 trillion. And this debit is not simply because new students are going to school. Nope, it’s also because folks with college degrees are behind in their loan payments, which increases the total interest costs. (The New York Federal Reserve estimates that 1 in 4 people with student loan debt is behind in their payments.)

2. The cost of a college education is rising fast. From the 1999 school year to the 2009 school year, tuition and room and board at public institutions rose 37% and at private insituations rose 25%(adjusting for inflation).

All of these statistics — and more — have some economists worrying that student loans are the new economic bubble. Like the tech and real estate bubbles, if this one bursts, the country could be in for another deep recession, this time with the federal government holding the bag.

So what the heck are colleges, parents and students doing to slow down this fast-moving train? Elgin Community College (ECC) in Elgin, IL is getting proactive, requiring financial aid counseling to students who are seeking federal student loans.

“The feedback has been positive,” says Amy Perrin, ECC’s director of financial aid and scholarships. “Students have expressed appreciation for educating them on the loan basics, budgeting, percentage interest rates and expected monthly payments.”

But student expectations are still a big issue. “We’ve had several students walk in with an inflated idea of what they ‘want’ to borrow — and walk out with a better understanding of what they ‘need’ to borrow,” Perrin says.

Student loans aren’t free money. And unlike other debts, these loans can follow a person forever, since they cannot be discharged in bankruptcy. It’s not just the math that trips students up.

“There seems to be a conflict between the Department of Education’s regulations and the student’s reality,” Perrin says. “The loan advising meeting covers many concepts, including creating a budget, interest rates, monthly payments, the student’s rights and responsibilities, and the consequences of default. After meeting with the staff, they should have a good understanding of the basic financial concepts of borrowing a student loan.”

So how can math help? A solid understanding of interest payments is critical here, and although there are online calculators that can help students estimate the total cost of these loans, students must have some basic math skills in order to use them. Perrin also suggests that parents and schools work harder at developing financial literacy skills.

“Parents can definitely play an important role in educating their children on basic financial concepts such as budgeting, how to open a checking account, why having a savings account is important and explaining ‘wants’ vs. ‘needs,’” she says. “Additionally, high schools should infuse financial literacy concepts into their classroom curriculum to further communicate the importance of wise financial decisions. High schools can partner with colleges to offer financial aid awareness events for parents and students.”

This student loan debt isn’t going anywhere any time soon. Unless we turn on our math brains and really deal with the numbers behind these scary statistics, our country could end up in another ugly economic place. Here’s hoping that other colleges require students to attend these programs–so that college degrees can actually mean something more than a monthly debt that must be paid off.

I’ll be the first to admit that my understanding of student loans is limited. So if you have questions, I completely understand! Post them here, and I’ll find the right expert to answer them. 

Photo courtesy of The Consumerist

There may be no more confusing place for math than with credit and debt — and there may be no more important place for A+ math skills than with your money.  That’s why I was asked to guest post at credit.com’s News+Advice blog today.

In my post, I discuss three ways that having some math skills — and a little dose of confidence — can help you make better decisions about what you owe and how you’ll pay it off.

Please join me at credit.com, and ask your questions there or in the comments section here!

Math for Grownups: A Simple Approach to Your Debt and Finances

By the way, would you like me to guest post at your blog?  Or do you know of a blog that I would fit right in with? I’ve got lots of ideas to share with anyone who will listen! And I promise I’m a good guest.  I wipe out the sink after I brush my teeth and don’t mind if the cat sleeps on my pillow.  Get the details here.  

Photo courtesy of iDanSimpson

I don’t usually post on Sundays, but with Geithner’s debt-ceiling deadline looming on Tuesday, I wanted to share this really great video.  Using some math and graphs, the narrator explains the debt, deficit and debt ceiling in ways that even your 4th grader can understand.

It’s a little long — almost 10 minutes — but trust me, it’s not full of the gobbledy-gook that economists are sometimes famous for.  You will be smarter after you watch it.  Promise.

Questions?  Ask them in the comment section.  (But please skip the political comments. Math is neither Democrat nor Republican.)

Also, be sure to come back tomorrow for an exciting August announcement!

As I was planning my posts for the week, I came across this fantastic video about the U.S. deficit and debt.  At first I had it scheduled for Friday, but with Geithner’s debt ceiling deadline looming on Tuesday, I decided you would probably benefit from seeing it sooner.  Who knows what will happen this week, right?

No matter what happens, you may have been wondering about the math involved with the deficit, debt and debt ceiling.  This handy video will lead the way.  It’s a bit long — almost 10 minutes — but very easy to follow and worth every second.  You’ll end up being  a much smarter person for watching it!

Questions? Ask them in the comments section! (But keep the political commentary for another site, please.)