Debt Consolidation & Debt Ratio

When you're consolidating debt, your debt-to-income ratio plays a role.

When you're consolidating debt, your debt-to-income ratio plays a role.

Debt consolidation is a method of debt management that many people consider, but as the finance website Bankrate.com warns, 70 percent of Americans who take out loans to pay off credit cards end up with as much or more debt within two years of doing so. That's why it's important to keep your debt down once you consolidate it. Financial advisers warn those who are considering debt consolidation to be on alert for predatory debt consolidation companies whose services come with high interest rates or hidden fees.

Types

Debt consolidation can be handled in more ways than one. If you're qualified to receive a credit card with 0 percent interest, this is one option. Keep in mind that the 0 percent interest rate expires after a certain amount of time and then a higher interest rate is applied to the account; find out when this time period ends and make sure to pay off your debt before the interest rate changes. You can consolidate all of your debt, or as much as you can fit, onto your credit card and just make your payments to the credit card company. The benefit to this option is the fact that you are not paying any interest fees and are still paying off your debt. A downfall is the fact that you have a high limit on a line of credit, which is a red flag on your credit report and will affect your credit score until the debt is paid. If debt consolidation on a credit card is out of the question, consider consolidating your debt with a home equity loan. When considering this option, make sure you're able to afford the payments, and find out what consequences could result from nonpayment.

Debt Ratio

Your debt-to-income ratio shows the amount of debt you have in relation to your income. This ratio is what lenders look at when deciding on whether to extend your credit or approve a loan. A low debt-to-income ratio shows that you know how to effectively balance your debt with your income.

Debt Ratio Calculation

To calculate your debt-to-income ratio, add up all of your monthly expenses and obligations -- including your mortgage or rent, car payments and credit card payments. Do not include variable expenses such as groceries, utilities or entertainment. Divide this amount by your gross monthly income to determine your ratio. For example, if you have monthly obligations and expenses that equal $3,000 and you're making $8,000 per month, your debt to income ratio is 0.375, or 37.5 percent, which is generally considered good.

The Relationship

Your debt-to-income ratio can have a major effect on the options you have to consolidate your debt. If you have a high debt-to-income ratio, chances are you won't qualify for a credit card with a 0 percent interest rate, and most lenders will not approve you for a loan, even if it is to consolidate your debt.

 

About the Author

Akeia Dixon is a freelance writer who began her professional writing career in 2009 for various websites. She enjoys writing about natural health topics but also loves to research and write about her findings on any subject. She is currently in school studying psychology and sociology.

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