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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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