Your debt to income ratio is an indication whether or not you have too much debt. Many lenders look at your debt to income ratio to determine if you qualify for a loan or to decide how high your interest rate should be. If you have too high of a debt to income ratio you get higher interest rates since you have a higher risk of defaulting on a loan.
What Is Debt to Income Ratio Used For?
Lenders use debt to income ratio to determine whether you should be able to manage the current debt payments. Most companies will not lend to you if your debt to income ratio is higher than 35 percent. If it is higher than 40 percent, you have a very high risk of defaulting on the loan. You can also use the debt to income ratio to determine if you have taken on too much debt and then begin to make the changes necessary to get your debt under control.
Finding Your Debt to Income Ratio
To find your debt to income ratio divide the total of your monthly debt payments including your mortgage by your monthly income. The number you get is your debt to income ratio. A number below 0.25 is excellent. If you have a debt to income ratio of between 0.25 and 0.35 you are in the acceptable level. The higher you go after that the more risk you have on defaulting on your payments. If you have more than 0.50 you are in serious trouble and need to work on improving your ratio immediately.
Improving Your Debt to Income Ratio
You can improve your debt to income ratio by reducing your debt or by increasing your income. To reduce your debt set up a debt payment plan by listing your debts from the highest interest rate to the lowest. Apply any extra money you get to the first debt until you have paid it off. You can increase your income by finding a new job or taking on a temporary job while you pay down your debt. However, a temporary income increase does not truly improve the problem. It needs to be a permanent change.
Warning Signs Your Debt to Income Ratio Is Too High
If you are having a difficult time paying the minimum on your credit cards and meeting your other monthly obligations your debt to income ratio is likely too high. You may find yourself putting money on your credit card each month because you can no longer afford to cover the basics in order to pay your debts. You should work on a solution to reducing your debt as quickly as possible so you do not miss any payments and you protect your credit score.
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