Definition:-
The debt-to-income ratio is the percentage of one’s income he/she use to pay off his/her debts. Banks and other lending institutions use one’s debt-to-income ratio to gauge his/her ability to repay debt. If one have a low ratio, he/she have a better chance of repaying his/her debt. If one has a high ratio, he/she is viewed as a credit risk, which could prevent him/her from finding affordable credit.
Calculation for Debt equity ratio:-
To calculate the ratio from your personal finances, first add up all your liabilities. Liabilities include home loans, auto loans, and any personal outstanding loans in addition to credit cards and bills owed. Next, add up all your assets which should include your home appraised value, car appraised value, and all amounts in your savings, checking, 401K, IRA and investment accounts. Simply divide your debts or liabilities by your assets and this is your current debt to equity ratio. Start tracking this ratio on a yearly basis. To make it easy to remember, pick a time you usually review all your financial accounts such as at the end of the year, or during tax time in April.
There are two standard formulas used by many lenders, especially those who focus on mortgages, to analyze your ability to afford to take on additional debt. Their definitions are:
· Gross Debt Service ratio (GDSR): The rule is monthly housing costs, usually defined as mortgage payments (combined principal and interest) plus property taxes, secondary financing, heating and 50% of condominium fees, if applicable, should not exceed 32 per cent of monthly household income before taxes
· Total Debt Service ratio (TDSR): this calculation compares monthly income to housing costs (same as GDSR) plus payments on lines of credit, credit cards and other debt. Housing costs plus debt payments shouldn’t exceed 40 per cent of income.
It is important to find out what your debt to income ratios are and if you can afford to increase your debt load. This is a first step to knowing whether you are potentially in financial trouble. .
Significance of debt-to-income ratio 1. 36% or less : This is the ideal amount of debt for most people to carry.
2. 37%-42% : At this level start reducing spending now before you dig yourself further into debt.
3. 43%-49% : Financial distress is right around the corner unless you act quickly to prevent it.
4. 50% or more : You need professional assistance to severely reduce your debt.
Debt to Equity Ratio as a Personal Financial Indicator
Debt to Equity ratio, also known as Debt to Asset Ratio, is a valuable indicator to both analyzing business financial statements as well as your personal financial health. A debt to equity ratio is simply total debt divided by total assets or equity. For example, if your total assets equal $200,000.00, and the total of all your liabilities is $140,000.00, your debt to equity ratio would be 0.7 or 70%.As a general rule, debt to equity above 80% is considered very risky and financially unhealthy. Usually young singles or couples purchasing their first home with little money down will fall into the 80% or higher debt to equity ratio category. As you build income capability over the years and grow your savings account, a more ideal debt to equity ratio would be in the range of 25% – 50%. Typically older couples will have %50 or less debt to equity ratios.
Dealing with a High Debt to Income Ratio
If your debt-to-income ratio is too high, don’t panic. There are two obvious options, lower your monthly debts (cut back on the use of your credit cards) or increase your income. We know this is not as easy as it sounds, but to improve your money management skills you will have to make changes. The easiest way is to stop the frequent use of your credit cards. Put them away.
If your debt-to-income ratio is too high, don’t panic. There are two obvious options, lower your monthly debts (cut back on the use of your credit cards) or increase your income. We know this is not as easy as it sounds, but to improve your money management skills you will have to make changes. The easiest way is to stop the frequent use of your credit cards. Put them away.
Steps to Reduce the debt:-
1. Take responsibility of your finances –
2. discover your own spending habits,
3. how to make smarter purchases, e
4. ducate yourself and you will lower your debt-to-income ratio.
Conclusion
Banks and other lending institutions use your debt-to-income ratio to gauge your ability to repay debt. If you have a low ratio, you have a better chance of repaying your debt. If you have a high ratio, you are considered a credit risk, which could prevent you from being approved for a loan or mortgage. In order to discover if you are in a good financial position, you must determine how much you spend each month to pay off your debts and other financial commitments. Your debt-to-income ratio is the percentage of your income you owe in debt or debt payments. Most financial experts agree a healthy debt-to-income ratio is 36 percent of your gross income.