To stay out of debt, you must spend less money than you earn. Implementing this financial plan is often more difficult than it would seem. Your debt to income ratio is an important part of your overall credit history. If you spend more money than you earn, your debt to income ratio will be high, making it hard to finance a home or make major purchases. There are two basic factors are used in calculating your debt to income ratio - your net worth and your total debt. There are standard guidelines used in the credit industry to determine if your debt to income ratio is too high. The standard may be a bit low due to the fact that many have an acceptable debt to income ratio but still struggle to pay monthly expenses. Your total net worth includes your monthly net pay, overtime and bonuses, and any other annual income. Your total debt includes your mortgage, other loan payments or revolving accounts, car payment, credit cards, and any child support you pay. If you divide you total monthly debt payments by your monthly income, you have your debt to income ratio. In the eyes of a creditor, if your debt to income ratio is lower than 36% you are in good financial shape. However, your personal situation, your unique expenses, and your number of dependants will determine how much debt you can reasonably pay each month. If your debt to income ratio is less than 30 percent, you are in excellent financial condition; 30-36% - you will have no trouble with lenders, but should work to bring this number down to 30 or less; 36-40% - you will most likely be able to get a loan, but you may have trouble meeting your monthly obligations; 40 percent or higher - you will need to evaluate your finances and work towards eliminating debts. Your credit card debt plays a major role in determining your debt to income ratio. The amount you owe on your credit cards has a direct bearing on your credit score. If your debt exceeds your income, your credit score will drop. Many factors go into determining your credit score, all of which are indicators of your overall financial health. Lowering credit card debt is one of the best ways to improve your credit score and your debt to income ratio. The average American has over $8000 in credit card debt. If you are paying the minimum payments each month, this still takes a big bite out of your income. Even if your credit history is excellent, with very few or no late payments, if you have too much debt, you could be denied a loan. Take control of your credit score by lowering your credit card debt or eliminating it all together. Your credit score will rise and you will lower your debt to income ratio. If you plan to apply for a loan, purchase a new home, or want to buy a new car, you must make sure your level of debt does not exceed more than 36% of your income. In addition, if you have several credit cards with very low or zero balances, you would benefit by closing those accounts and transferring any outstanding balances to a credit card with a low interest rate. Some lenders will calculate your debt to income ratio based on the amount of credit that is available to you. If you have several dependants, you may want to lower your debt to income ratio to around 20% to ensure that you can pay your monthly debt comfortably. |
