Generally, the lower your debt-to-income ratio, the better is your financial condition. A recommended debt-to-income ratio is under 15 percent. A ratio of 20 percent or higher signals a need to control credit and to begin a plan for regaining financial stability. Ideally, you will carry little or no debt so your income can be saved, invested, or spent as desired, rather than used on interest.
Your debt-to-income ratio
- 20% or less: This is a healthy debt load to carry for most people.
- 20%-35%: Not bad, but start paring debt now before you get in real trouble. You should look carefully at your monthly payments and expenses and start decreasing your overall level of debt.
- 35%-50%: Financial difficulties are probably imminent unless you take immediate action. You should stop accumulating debt and start looking for ways to decrease your total debt level.
- 50% or more: Get professional help to aggressively reduce debt.
Why is monitoring your debt-to-income ratio important?
You can avoid "creeping indebtedness" by staying aware of your debt-to-income ratio. Knowing your debt-to-income ratio will help you manage your personal finances. Keeping your debt-to-income ratio under 20 percent will help you avoid major credit problems.
Because it is such a powerful indicator, lenders look at your debt-to-income ratio when they consider extending credit. Letting your debt-to-income ratio rise will jeopardize your chance of making major purchases, such as a car or a home, when you desire. Also, if your ratio is high, you will find it difficult to get additional credit in case of emergencies. As a bonus, if you keep your debt-to-income ratio low, you will more likely qualify for the lowest interest rates and best terms when you apply for credit.