Few people understand what a debt to income ratio is, but it is critical to understand this important number if you want to get control over your finances and credit. This ratio is used to determine everything from whether or not you can qualify for a loan to whether or not you are in good financial shape.
Of course, in order to understand how this ratio will affect your financial life, you must first understand exactly what this ratio means and how banks interpret it. A debt to income ratio is simply a comparison of your total amount of debt you currently have to your annual salary. In some cases, this ratio is computed as a comparison of a person’s monthly debt payments to their monthly income. Each of these ways of computing a debt to income ratio can produce different numbers, and it’s important to understand the differences between these figures.
Two Types Of Debt To Income Ratios
The first type of debt to income ratio looks at the total principal amount that you owe on all of your debts. For example, if you have $15,000 in credit card debt and $200,000 on your mortgage, your total debt is $215,000. The amount of interest that is charged on the debts has no bearing on the calculation. Your total debt amount is then compared to the total amount of money you make every year. If you make $215,000 a year, your ratio is 100%.
The second type of debt to income ratio is often called a debt repayment to income ratio. To calculate this figure, add up the total amount that you pay each month towards your debt. Compare this number to the total amount that you make in income.
How To Know If You Have Too Much Debt
Both of these ratios are used by banks to determine your credit worthiness, and both of them offer some insight into your overall financial health. The first ratio is used to determine if you have too much debt. In general, people who have less than three times their total annual salary in debt are considered to be financially secure if a part of that debt is tied to an appreciating asset such as a house.
If your debt is made up of only unsecured debt, such as credit card debt, it is considered financially healthy to have a debt to income ratio of less than one. In other words, if you have more debt than you could pay off in a year, you have too much debt.
The second way to calculate the debt to income ratio helps you to consider if your payments are too high. In general, it is considered healthy to owe less than a third of your gross salary every month to secured debts, such as mortgages. Less than 10 percent of your gross salary should be used every month to pay your unsecured debts.
What To Do When Your Debt Level Is Too High
If you are paying more than these amounts every month, the amount you are paying towards debt is too high. If your debt level is considered acceptable under the first ratio, but too high under the second ratio, it probably means that you are paying too much towards your debts. Often, this means that you are paying a higher amount of interest and penalty fees than you should be.
Fortunately, there are ways to get out of debt if your debt to income ratio is too high. Many people have turned to debt settlement services to get rid of their debt. These services are able to negotiate with your creditors and lower the total amount that you owe. By doing this, a person is able to see an immediate reduction in the debt to income ratio. In many cases, this makes them eligible for loans and other opportunities that they otherwise would not have qualified for.
If you think that your debt to income ratio is too high, call now or fill out the form for your free debt relief quote. This will give a credit relief counselor enough information to contact you and start to determine if debt settlement is right for you.