Debt has a way of dictating your financial life. The credit available to you and the debt you owe determine many of the most important decisions in life, such as where you live, what you drive, where you vacation and what you wear. A few debt ratios calculate your financial well-being in various ways, each with its own ideal set of numbers.
Debt-to-Income Ratio
The debt-to-income ratio is used by creditors to determine your credit worthiness for a line of credit, such as a mortgage. This number figures in your total monthly debt obligations, including credit card payments, mortgage or rent, car payments and other debts. This number is divided by your total gross monthly income (your income before taxes). Ideally, lenders want to see a debt-to-income ratio of 36 percent or less, though up to about 42 percent is generally deemed acceptable.
Debt-to-Credit Ratio
The debt-to-credit ratio is used by credit scoring companies to create your FICO or credit score. This takes your total debt on revolving accounts like credit cards and divides it by the total amount of credit available. For example, a man who has $4,000 on a card with an $8,000 limit has a debt-to-credit ratio of 50 percent. In fact, 50 percent is the highest ideal debt-to-credit ratio if you want a good to excellent credit rating.
Debt-to-Assets Ratio
The debt-to-assets ratio in personal finance, also referred to as the debt-to-equity ratio, takes the total amount of debt owed by a person and divides it by the total cash value of the person's assets. Calculating this can get a bit complicated. Debts include mortgages, credit cards, car loans, student loans and the like. Assets are anything of monetary value, including cash, savings, stocks, bonds, and cash values on property, such as homes, land, vehicles, jewelry, art and other valuables. While most people starting out will have a ratio in the vicinity of 80 percent, ideally you should hold a debt-to-assets ratio of 50 percent or less.
Considerations
While all of these debt ratios are ways to check your financial fitness, do not despair if your ratios are not near the ideal range. By employing good personal financial management with budgeting, sound investments and savings plans, you can get your finances headed in the right direction. Consider consulting with professionals if you feel you need guidance to improve any of your debt ratios. Most importantly, remember that these ratios are ideals to strive for and only indicate your financial well-being, not your worth as a person.
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