US citizens take debt for multiple reasons, like buying a home, getting education, etc. According to the Statista Report, in October 2022, the public debt of the USA was about $31.238 trillion, which is around $2.3 trillion more than the figure ($28.9 trillion) of 2021. This data reveals that the majority of US citizens take debt to fulfill their dreams; indeed, the U.S. household debt is surging. In addition, missed payments, delinquencies, etc., show that many Americans (might be you as well) own too much debt for their budget. You may be one of them who might have taken or are planning to take debt for your personal use but are not sure how much debt is ok or too much for you.
In this write-up, we will walk you through everything about debt, debt-to-income ratio, how to calculate debt, etc., so that you will quickly know how much debt is sufficient or too much for you. Without further ado, let’s get started from scratch.
What is the debt-to-income ratio, and why is it important?
In simple words, debt-to-income ratio refers to the ratio that compares all your monthly debt expenses to your gross monthly income. This is a crucial way that lenders use to measure how much debt you can take. By knowing the debt-to-income ratio, you can easily manage your debt payment and repay it to the lender.
What is the right way to calculate your debt-to-income ratio?
Calculating the debt-to-income ratio is not a taxing task. To calculate the ratio, you will first have to create a list of your monthly household debts. Remember always - debt is the payment that you borrow from a lender to repay him back. So, avoid monthly expenses like groceries, medical, etc., as they won’t be included in DTI. So the list includes auto loans, student loans, credit card debt, medical bills, home mortgage payment etc., on which you make monthly debt payments.
Additionally, calculate your monthly take-home payment. Once you have these two figures in hand, divide the total monthly debt payment by your monthly income. You will get the resultant number equal to or less than one, like 0.35 or 0.23. Now, multiply this figure by 100 to see the percentage of your take. As per the financial experts, DTI of at least 15 to 20 percent of the net income is good.
Let’s understand with an example - a family owes a debt of $350 dollars, including $250 of a car payment and $100 of monthly credit card payments. And their $2500 net income monthly would have a DTI of 14% ($350/$2500 = 0.14 or 14%).
How to lower the debt-to-income ratio?
Is your debt higher than the net income? Want to reduce your debt?’ If yes, there are numerous smart ways to reduce your debt to income ratio and the major two are: refinancing student loans and consolidating credit card debts.
Talking about consolidating credit card debts, you can quickly lower your monthly payments and spread repayment over the years. In addition, it can save you considerable time when it comes to interest rates, as credit cards come with higher interest rates than personal loans or balance transfer credit cards.
Likewise, you can refinance the student loan if your monthly payment is too high. Refinancing lets you extend the repayment term, thus lowering your monthly income. But make sure you’re comfortable enough to pay more interest over the life of the loan instead of this lower payment. This is how you can easily lower the debt.
Is there anything like good or bad debt?
If you’re not aware of good or bad debt, then let’s understand it in detail below. Understanding good and bad debt will clear your major doubts.
What exactly is good debt?
When the interest rate is low and fixed, and the loan that you use to purchase something that grows in value like education, business, or house. It is too good if the interest is tax-deductible, like student loans and mortgage interest.
What is bad debt?
The debt with a high-interest rate is used to buy things that ultimately lose value over time or become depreciated. For example, high-interest personal loans for discretionary purchases such as auto loans, vacations, etc.
Now you have a clear idea of good and bad debt.
Crucial signs revealing you own too much debt
It might be difficult for you to bear if your debt is too high. But how to know whether the debt is too high or not? Here is the rundown of the warning signs exhibiting that you own too much debt, which includes:
You’re frequently being charged over-the-limit fees
Not able to pay off the credit card in a year
Debt balance is not lowering despite regular payments
Use of credit cards for cash advances
Living paycheck to paycheck, with no money at the end of the month
No funds for emergencies
Making the minimum payments only
Paying off an existing credit card with another one
Borrowing money from family or friends
Credit card payment is more than debt
And the list goes on. These are the typical signs revealing that you own too much debt, which needs to be cleared soon.
To sum up
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