What Is a Good Debt to Asset Ratio?
There are many figures that are important to your financial health. They help you understand your current status, where you should be, and how to get there. They also help lenders determine whether or not you can qualify for loans. Debt ratios, also known as debt to asset ratio, and equity-to-asset ratios are both key figures to know. What are debt ratios and equity-to-asset ratios? How do you calculate them? How do you understand what they mean for your financial situation? How do they help with the loan process?
Here is your guide to debt to asset ratios.
A debt ratio is also called a debt to asset ratio. It is the relationship between your total debt and your total assets. It is typically used to refer to a company’s financial health, but it can also apply to individuals.
To calculate your debt ratio, you would first determine your total debt. This consists of all monthly payments, including credit card payments, payments for car, personal, mortgage, and student loans, and other monthly bills. It does not include insurance payments and living expenses, since these are expenses rather than debts and are never paid off.
Next, you would calculate your total assets. This includes your gross monthly income, which is what you make before taxes are taken out. It could also include stocks, bonds, and other assets.
Now divide your debts by your assets. You should arrive at a percentage which represents the percent of your income and assets taken up by debt. For example, if your debt ratio is 50 percent, this means that for every dollar of assets, you have 50 cents of debt. The percentage is typically expressed as a decimal, so 50 percent would be 0.5. Any ratio that is higher than 1.0 would mean that you have more debt than assets to cover it, putting you in a very precarious position. This usually is indicative of someone who is barely keeping their head above water, so to speak.
To lenders, your debt ratio indicates your degree of leverage, which in turn indicates your level of risk. A very high debt to asset ratio would mean you are very high risk, and it’s likely that you would be rejected for loans. Even if you are accepted, perhaps due to good payment history on your credit report or another factor, you will likely have to pay a high interest rate. It’s always better to aim for a low ratio. Not only will this guarantee an acceptance by lenders, it will also provide you with lower interest rates, which will lower the cost of the loan overall.
Even if you have a decent debt ratio, you may still have a difficult time receiving a loan. The lender will be looking at how you will handle the loan. They will consider what may happen if you suddenly find yourself with medical bills or out of work. They will want to make sure that you will still be able to keep up with payments. When the lender calculates your debt ratio, they will likely include the potential costs of the loan being applied for in your total debt. This will give them an accurate picture of your ability to repay the loan. They want to see a “cushion”, meaning you have plenty of breathing room. If your financial situation changes or interest rates were to rise, this cushion will help you stay afloat.
A “good” debt ratio could vary, depending on your specific situation and the lender you are speaking to. Generally, though, a ratio of 40 percent or lower is considered ideal, while a ratio of 60 percent or higher is considered poor. You may notice a struggle to meet obligations as your debt ratio gets closer to 60 percent.
Another ratio that is used to measure financial leverage is the equity-to-asset ratio. It is typically used to measure the health of a company’s balance sheet. It is the difference between net worth, or equity, and total assets.
Assets are all the resources that hold economic value. This would include cash, property, equipment, inventory, and materials.
Equity is the difference between assets and liabilities. Liabilities are debts and would include business loans, company credit cards, vehicle loans, and others Equity is typically used to determine a company’s net worth by subtracting liabilities from assets. This will give you a figure that represents the assets that are not taken up by debt.
The equity-to-asset ratio can be found by dividing the equity by the total assets. This will give you a percentage, which indicates the percentage of the company that is owned by investors. For example, if the equity-to-asset ratio comes out to 25 percent, then that means that the company and its investors own a quarter of the company outright. The other 75 percent is controlled by debt holders. In the event of bankruptcy, this is the portion of the company that debt holders could claim.
Contrary to a debt ratio, which should be as low as possible, an equity-to-asset ratio should be as high as possible. 100 percent would be ideal, but there isn’t a set number that indicates trouble for a company. The key thing to remember is that this ratio isn’t about the number itself, but how it relates to others in the same industry. This is because some assets could carry higher leverage. This usually applies to assets that continually generate value and income, such as real estate and pipelines. So a low equity-to-asset ratio is not necessarily a cause for alarm, since these varying levels of value need to be taken into account.
Keep Your Debt to Asset Ratio Low to Keep Yourself in Good Standing
Your debt to asset ratio, or simply debt ratio, is a strong indicator of your financial health. You should strive to keep it as low as possible, shooting for 40 percent or lower. This will keep you from falling behind on debts, and will also make you look more attractive to lenders. To lower your debt ratio, you can work on reducing your debts, perhaps by paying off smaller ones, and increasing your income – perhaps a raise or higher-paying job is in your future. Even if you are not planning to apply for new loans, getting a handle on your debt will always help you in the long run.
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