What is a Personal Debt Ratio?

A personal debt ratio is a calculation of the total debt carried by an individual in comparison to the worth of any assets also held by the individual. The concept of personal debt ratios is often used by creditors to determine if an applicant for a loan or some other types of financing presents a degree of risk that the lender finds unacceptable. Identifying this type of ratio is also helpful when it comes to establishing a household budget and engaging in the task of personal debt management.

With a favorable personal debt ratio, the individual owns assets that have a greater market value than the total amount of his or her outstanding debts. For purposes of evaluating the financial condition of the individual, both secured and unsecured debt will be considered. This means that a homeowner with property that is currently not mortgaged but does have some credit card debt will have a favorable ratio. At the same time, a homeowner with relatively little equity in the real estate and a considerable amount of debt in the way of a car loan and credit card debt could possibly have an unfavorable ratio.

As with company debt ratios, personal ratios are usually arrived at by dividing the amount of debt by the total worth of assets. If the emerging personal debt ratio is one or more, this indicates the consumer has more debt than assets and may be at greater risk for defaulting on all or a portion of that debt. In this scenario, potential lenders and creditors may see this as an indication that the consumer should not assume any additional debt and will not approve applications for loans or credit accounts. Should the personal debt ratio be less than one, this indicates the consumer has more assets than debts and could be a reasonable credit risk.

In terms of personal budgeting, determining the personal debt ratio for a household is a great way to maintain some perspective with budget planning. Calculating the ratio from time to time helps households identify if they are in fact moving toward a more stable financial condition, or if they are reaching a point in which assets are being overtaken by liabilities. The results of the calculation can aid in making adjustments in spending and to the budget in general, hopefully making it possible to achieve a more desirable personal debt ratio in the months to come.