What is Debt Service?
Debt service is money owed on a regular schedule, such as weekly or monthly, to cover a debt. It must be included in expense estimates and people concerned about finances may look at the ratio of their debt service to disposable income and other financial obligations. Having a high debt service makes it difficult to save money or make investments and can contribute to the development of insolvency. Financial analysis for individuals, companies, and governments can all incorporate an estimate of how much money is being paid every year to retire debt.
Some examples of individual debts include consumer debt like credit cards, mortgages, and car payments. Governments typically pay debt service on their national debt, the money borrowed to finance government activities, while companies must service debts associated with investment in new technology, acquisitions, and so forth. Carrying debt is very common and sometimes becomes necessary to finance expansion and opportunities.
Debt service payments include payments on the principal to reduce the overall amount owed, along with interest. If payments are regularly late or insufficient, fees will apply as well and can be considered part of the debt service. People can reduce the amount they pay over time by paying more than the minimum every month to retire the debt more quickly and limit the buildup of interest. Repayment of debt can take up varying percentages of income, but generally no more than a third of one's income should be spent on paying down debts.
High debt service is a cause for concern. If very little disposable income is left at the end of each month, this represents limited opportunities for savings. It may be necessary to take on more debt in the event of an unexpected financial expense, and this will in turn increase the debt service and make it even harder to save money. When multiple large debts are outstanding, people are often encouraged to prioritize the payments to pay down higher interest, higher balance debts first, with the result of getting interest payments down as quickly as possible.
Governments and publicly traded companies must disclose their debt servicing expenses and these disclosures can be inspected by anyone upon request. Evaluating this information is useful for investors and economists interested in making financial projections and studying financial health. For individuals, it is usually necessary to disclose outstanding debts on loan applications, as lenders make decisions about whether to lend and how much to offer on the basis of how much debt service they think people can afford.
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