Whether you're lusting after a shiny new car, hoping to upgrade to a home in a trendy neighborhood or just scrounging up the money for retirement, debt can impact your financial security. Because debt can affect the amount of money you have available to save and can cause serious problems if you lose your job, no amount of debt is completely safe. But lenders often look at debt loads to determine how risky a borrower is, and larger debt loads increase the likelihood that you'll run out of money to pay your obligations.
Debt Load Basics
No predetermined amount of debt is safe for everyone. Five thousand dollars of debt could be massive to some people and inconsequential to others, depending upon their income and financial obligations. Consequently, most lenders and financial planners examine debt-to-income ratios. This calculates how much of your total income goes to servicing debt each month. If you make $4,000 a month and have to pay $1,000 toward debt, your debt-to=income ratio is 25 percent. The higher your debt-to-income ratio, the more financial risk you face.
Mortgage and Debt
Mortgage lenders don't look only at your credit when deciding whether to give you a loan -- they also examine whether you're saddled with debt. Your front-end debt ratio is a measure of how much of your income will go to your housing costs, including your mortgage and property taxes. Most lenders prefer that this ratio is 28 percent or less. To calculate this number, divide your monthly income by your monthly housing expenses, then multiply the result by 100.
Loans and Debt
Credit cards, auto financing and student loans can all increase your debt burden. Your back-end debt ratio is how much of your income goes toward all of your debts. This number should be no higher than 36 percent. Ratios higher than this can interfere with your ability to refinance and get loans, and also increase your likelihood of landing in financial hot water. Calculate your back-end debt ratio by adding all of your monthly debt payments. Then divide this sum by your monthly income and multiply the result by 100.
Reducing Debt Load
The only way to reduce your debt load is to pay down your current debts and avoid taking on new ones. You might need to stay in your home a little longer or reduce the amount you spend buying a new home. Paying down debts with high interest rates first can help you reduce your debt more quickly, and if you have high mortgage payments or an adjustable rate, refinancing could help.
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