Normal Debt Ratio
A person's debt-to-income ratio is often a telltale sign of the person's financial health. A person's debt-to-income ratio depends on the amount of debt and the person's monthly income. A low debt-to-income ratio is ideal in all situations, although sometimes impossible to obtain in certain circumstances. A lower debt-to-income ratio is looked favorably upon by credit card companies and banks.
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Defining Debt-to-Income Ratio
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Debt-to-income ratio is expressed as a percentage. The percentage is the amount found after dividing someone's monthly debt by their gross monthly income. For example, if someone made a gross monthly income of $3,000 and had debt payments of $1,000, their debt-to-income ratio would be 33 percent. Not everything someone pays toward in a month is considered debt. Only a person's monthly rent, mortgage, minimum credit card payments, monthly car loan payments and other loans are considered as debt. Varying expenses, such as groceries and gasoline, are not considered debt.
Normal Debt-to-Income Ratio
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A healthy debt-to-income ratio is 36 percent or below. Anything up to a 43 percent ratio is considered OK and means that the person likely will not face any financial difficulties. Debt-to-income ratio isn't only important for predicting financial security, it's also important when applying for loans or credit cards. For example, someone with a 36 percent or less debt-to-income ratio has a much higher chance of getting approved for a mortgage loan than someone with a 40 percent ratio.
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Low Income
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Someone with low income typically has an entirely different debt-to-income ratio than someone who has a higher income. For example, a recent college graduate who is only making $1,000 per month is probably going to have a higher debt-to-income ratio than a 40-year-old person making $6,000 per month. The college graduate might have less total debt, but that debt impacts his debt-to-income ratio dramatically. If the college student has a $200 car payment plus a $500 rent payment, his debt-to-income ratio is 70 percent.
Income vs. New Debt
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Many people worry that taking on new debt will completely ruin their debt-to-income ratio. That may be true, but only in circumstances where the debt the person acquires puts a significant dent in their monthly income. For example, if someone makes $4,000 per month, has $1,000 in debt and acquires a $200 car loan, their debt-to-income ratio jumps from 25 percent to 30 percent. However, the opposite holds true for people with low income. People with low income should avoid acquiring new debt at all costs, because even a small debt, such as $100 per month, can cause a significant debt-to-income ratio increase.
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