The fact is, most of us have debt. Some more than others, but it is a constant part of many of our lives. This can be something that you are comfortable with, or something that causes a lot of stress. And which camp you fall into may be linked to a subject that is not discussed much. The debt to income ratio.
Debt To Income Ratio – Example
Let’s use a perhaps bizarre example to show how the seriousness of a debt level is not always linked to the pure amount, but the ability to manage it. Manchester United have been saddled with debt ever since the Glazer family took over the club over 15 years ago. Debt currently is thought to total around £400m. That is a staggering amount that would sink most businesses globally with immediate effect. But Manchester United are under no threat of that whatsoever, In fact, expect them to spend another £100m+ in the summer in the midst of a pandemic. Why are they not at threat? Well not only because the value of the club itself dwarfs that debt amount, but their income means the debt is pretty easy to manage.
Too Much Debt?
So just how much debt should be considered too much, or excessive? That varies according to personal circumstances. A £1000 debt for me to buy a new computer could cause me sleepless nights, whilst a family may take on a £300k mortgage without any concern whatsoever. However, the general consensus is that debt should stay below 40’% of income whenever possible. Perhaps mortgages could be excused from that calculation as they are a unique form of debt and something of an outlier during this debate.
Debt-to-Income Ratio
Many people have no idea how much debt they have, so determining a ratio is not easy! So if that sounds like your situation, the first thing you must do is sit down and work it out. Use a similar formula that lenders rely on when evaluating a financial application. The ratio is simple. It is your total monthly debt payments divided by your gross monthly income. The result is a percentage that determines your creditworthiness. It says whether you are an attractive proposition for lenders. But just as importantly, it perhaps suggests how well placed you are to deal with your personal debt.
Debt To Income Ratio – Exclusions
As mentioned briefly already, your ratio typically excludes mortgage and perhaps also student loans. It takes into account credit card payments, auto loans, medical bills, personal and payday loans, and any other similar debts.
Debt To Income Ratio – Assessing Debt Ratios
Less than 15%: Your debt load is within an affordable range. Between 15% and 39%: Your debt load is stable but on the high end, especially the closer you are to 40%. 40% or more: Your debt load is high risk.
Debt in itself is not a bad thing, remember, it is more nuanced than that. Without mortgages for example, home ownership would be impossible for most people. Debt allows purchases to be made that would never be otherwise. But what is important is to separate your debt into two categories. Good debt, such as a low-interest loan or mortgage, against bad debt, such as a payday loan that comes with huge interest rates. Or a credit card that you can’t afford to pay off.
Take Action
If your debt-to-income ratio is high, taking steps right away is an absolute priority. For your future, your stress levels, and the peace of mind you will gain from confronting a debt problem. Try paying off high-interest credit card balances one by one. Seek advice from a financial adviser or debt counsellor if need be. It is their job to make your life easier and search for solutions.
