Your Debt To Income Ratio |
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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.
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