Debt Ratio 101
An important facet of determining ones credit worthiness is to look at their debt to income ratio. The debt ratio is essentially a way to determine how much of an individual’s monthly income is spoken for every month in the form of payments that are due. Typically, lenders do not like to look at loan applications with high percentages of monthly income allocated to debt obligations.
Case in point: For someone who earns $5000 every thirty days, and has a car payment of $450 per month, education loans demanding $120 per month, as well as a credit card (minimum) payment of $200 per month. The debt ratio is figured out by totalling the monthly payments, and dividing them into the amount of money coming each month ($5000). To sum it all up, the ratio of debt for this person is 15.4%.
For a corporation, the debt ratio is defined as the amount of debt a company has on the books relative to its assets. If a company accepted a loan from a bank of $1 million and the company has $2 million in assets on their balance sheet, the company’s debt ratio is 50% ($1 million divided into $2 million). A debt ratio of great than 1 (or 100%) would indicate that a company has borrowed more money than they have assets to show for it. For a company, the debt ratio will show investors and creditors just how much the company relies on debt to finance its assets.
So why would these numbers be important?
The answer is simple: whether you’re seeking a mortgage you’re going to want additional funds at some point. For a lender to want to closely look at your fiscal situation is a smart move on the lenders part.
A lender who makes home loans for example, may establish a rule that they will not issue a mortgage loan that would cause an individual’s debt ratio to exceed 38%. When the lender is deciding how large a loan an applicant qualifies for, they examine all outstanding debt and determine the maximum monthly payment that individual can handle without exceeding their 38% maximum debt ratio. People with high debt loads find it difficult to get a loan, and if they do, the interest rates are higher than average.
Debt ratio is crucial, so take yours seriously. Regardless of how much income you earn, you want to keep your ratio as “in the green” as possible. Lenders want to be absolutely sure that you can and will be able to make your payments on time.
One way to insure your debt to income ratio is in a good position is to consider using a debt settlement company to settle your debts for pennies on the dollar. Long term this will not hurt your credit and it will significantly lower your debt ratio..
- Jeff Emmerson
This entry was posted on Tuesday, June 16th, 2009 at 12:06 pm and is filed under Loans. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.
