Do you realize how much debt you have compared to how much equity you have? Calculating your debt-to-equity ratio will assist you in gaining a better understanding of your financial situation. It will show you what lenders and other credit assessing authorities see: whether you’re a suitable prospect for a loan, an apartment rental, or a job, or whether your debt status makes you a high-risk proposition.
Understanding your debt-to-equity ratio might also help you figure out where you should focus efforts to get your finances in great shape. What you should know about your debt-to-equity ratio and how to improve it are outlined below.
What is your debt-to-equity ratio?
The debt-to-equity ratio is an indicator of financial health. It shows how much debt a firm or person owes compared to their assets (capital, holdings, possessions) or equity. When you divide the total amount of outstanding debt (liabilities) by the value of your assets or equity, you will find the debt-to-equity ratio.
The debt-to-equity ratio of an individual with $100,000 in existing debt and total assets or equity, of $200,000 is 50% (because, $100,000/$200,000 x 100% = 50%).
How to know when you are in the dangerous financial territory?
Lenders may not be willing to provide you with credit or loans if you have a debt-to-equity ratio that indicates high risk. Your warning sign of this danger is a debt-to-equity ratio of 80% or higher.
It is common to find many young people in the debt-to-equity warning zone because they could only afford the lowest deposit when they bought their first homes. To resolve this issue, pay down the mortgage consistently and avoid taking on new debt. The debt-to-equity ratio will then gradually become reduced to a comfortable level.
How to reduce your debt-to-equity ratio
Take action by first calculating your debt-to-equity ratio. If it is in the dangerous 80% or more zone, pay down debt to reduce it. The impact of a high debt-to-equity ratio is weakened creditworthiness, which makes it harder for you to obtain a loan for a house or car, and could cost you landing a job.
Do the following to improve your debt-to-equity ratio:
1. List all your debts and monthly payments.
Write down all your liabilities owed like credit cards, loans, mortgages, car payments, and overdrafts. Then get your credit report to know what creditors will see. You can also challenge any errors or find debts you forgot to pay.
2. Plan ahead
Analyze each debt and strategize the best way to pay them down. Commit more money each month to pay down your debts and lower your debt-to-equity ratio. When faced with exorbitant interest rates, pay off these debts first. Then, start paying down more money on the least debt first. After, increase the amount paid each month on the higher debts as you progress further.
3. Get help
Get advice when you can’t find a strategy to pay off your high debts.
One option is a debt consolidation loan which replaces all outstanding debt with one loan at a lower interest rate. This option does not lower the debt-to-equity ratio but does make overseeing debt repayment simpler.
Another way is to use a debt settlement company to work out lower payments for unsettled debts with creditors.
Another is using credit counselors who can also help when devising ways for debt settlement and repayment.
The last option reserved for distressed financial situations with no realistic repayment or settlement options is to declare bankruptcy.
Measure your financial health
Calculate your debt-to-equity ratio right now. Find all your outstanding debts like credit cards, car loans, and mortgages and calculate your debt-to-equity ratio today. Your potential creditors will use the same indicator to assess your creditworthiness. Therefore, you should determine if your debts are in the dangerous debt-to-equity ratio zone so that there are no surprises.