Importance Of Having A Good Personal Debt To Equity Ratio
Debt to Equity ratio, which is also referred to as Debt to Asset ratio
, is an important financial indicator for the business as well as the person. This financial measure is derived by dividing the total debt with the total equity or assets of a person or business. This means that if your current debt load is $150,000 and your aggregate assets or equity is equal to $250,000, then your debt to equity ratio is equivalent to 0.6 or 60 percent.
In general, a debt equity ratio which is more than 80 percent is an indication that you are treading on dangerous territory and your finances are not standing on firm ground. In most cases, young couples breach the 80-percent mark when they purchase their first home with minimum down payment. As they continue to pay their monthly mortgage, they slowly increase their equity and reduce their debt load. As you grow old, it is expected that you have more equity and lesser debt load. A typical debt to equity ratio of an old couple should not be more than 50 percent.
Need for a Lower Debt to Equity Ratio
Of course, having a debt to equity ratio that is more than 1 or 100 percent is bad news. This only means that the amount of your debt is more than your total assets. Suffice it to say, you need to find ways to reduce your debt load while working to expand your asset profile in order to obtain a better (and lower) ratio.
You have to closely monitor this aspect of your finance health so that you never get yourself into situations where you can no longer manage your debt. As the ratio increases, you will also have to draw more from your regular income to pay up a growing monthly debt payment. This means that an increasing disbursement for debt payments will impact on your savings, which is part of your debt to asset ratio, and your level of consumption.
In addition to this, a lower debt to equity ratio is a mark of a sound financial health. For banks and other lending companies, this means that you are in the position to "support" any additional debt. Thus, a low ratio would mean a good credit profile, and this will easily translate to better deals and lower interest rates on your loans.
Leveraging your Debt Load
It is a natural course of action of any person not to admit that they are under-leveraged. It is only when we get into situations where we have to take stock of our debt and asset profile that we start to seriously consider the reality about our financial position. Being under-leveraged can be compared to using a wrench with short handle in loosening a bolt.
Your bank or lender may not be too enthusiastic in extending you a loan if you are under-leveraged, and in case you are able to get their nod, you will most likely have to contend with higher interest rate. Thus, it is foremost that you are able to leverage your debt load, and the best way to do this is by keeping track of your debt to equity ratio.
by: Gen Wright
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