by Charlotte Wood
(last updated February 21, 2009)
While your credit score is always important when taking out a loan or credit card, your debt ratio is also taken into consideration. First off, what exactly is a debt ratio? And secondly, how do you make sure you have a good one? Debt ratios are actually pretty easy to understand and once you do, you'll have a leg up on managing your money and debt.
The basics of the debt-to-income ratio are simple: it's just the ratio of your income to your debt. The ratio is expressed as a percentage, where the number is the percentage of your income you apply toward paying off debt and the lower the ratio the better chance you have at qualifying for loans and low interest rates. When calculating your debt-to-income ratio you divide your minimum monthly debt payments (excluding rent and mortgage) by your complete income (paychecks, child support, alimony, etc.). The resulting number is your debt ratio.
A healthy debt ratio, or at least an average debt ratio, is about 35 percent and below. Ideally your ratio should be about 15 percent, but if you're not above 35 percent then you're in excellent fiscal shape. You have a handle on your finances and are in good control of your debt. Regardless of whether or not you have a lot of money, what you do have is under control and ready to go where it needs to go.
A debt ratio between 36 and 42 percent is where you should start being concerned and figuring out a financial plan so you can start paying some of that off. If your ratio is between 43 and 49 percent start expecting significant financial difficulties in the near future and also expect a more stringent fiscal plan if you want to get yourself out of your debt. Anything above 50 percent means you're in a really bad situation. You should seek professional help and seek some real lifestyle changes if you want to remedy this circumstance.
If you can work your debt ratio down to 35 percent or lower then you'll qualify for the loans you want and the interest rates you want as long as your credit score is also in good shape. Now you have a better understanding of what your debt ratio actually is and what you should be shooting for you can gain a better grasp on your finances and make real and lasting plans for your financial future.
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