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Debt-to-Equity Ratio: What it Measures and Why it Matters
by
JG Wentworth
•
July 9, 2024
•
7 min
You know all those perplexing financial ratios and formulas that get thrown around when talking about companies and businesses? Well, believe it or not, there’s one that really matters for regular consumers too: the debt-to-equity ratio. Now before you tune out thinking this is too complicated, the debt-to-equity ratio is actually a pretty straightforward concept that can tell you a lot about your personal financial health.
This information is provided for educational and informational purposes only. Such information or materials do not constitute and are not intended to provide legal, accounting, or tax advice and should not be relied on in that respect. We suggest that You consult an attorney, accountant, and/or financial advisor to answer any financial or legal questions.
So, what does it measure?
Debt-to-equity ratio simply measures your debt load versus how much home equity you have. Here’s how it works:
- You take the total amount you owe on mortgages, loans, credit cards, etc. (your debts).
- Divide it by the current market value of assets you own outright (your equity, which for most people is just their home equity). That gives you your personal debt to equity ratio.
For example, let’s say you owe $150,000 total on your mortgage and other debts. But your home is worth $300,000 on the current market. That means your debt-to-equity ratio would be a reasonable 0.5 ($150,000 debts / $300,000 equity).
How is this different from a debt-to-income ratio?
It’s easy to mix these up.
- Debt-to-equity looks at debt relative to net worth/equity.
- Debt-to-income looks at debt payments relative to income.
Both are used to evaluate debt levels, but in different ways. The debt-to-equity ratio focuses more on net worth and assets, while the debt-to-income ratio deals more specifically with cash flow and the ability to make debt payments from income.
Why should you care about this number?
Having a high debt-to-equity ratio signals that you have a heavy debt burden compared to your net worth tied up in assets like your home equity. The higher the number, the more concerning it could be for credit lenders.
For this reason, economists and financial advisors generally recommend keeping your debt-to-equity ratio below 0.5 or so to be in a decent financial position. Anything approaching or above a 1.0 ratio means you have relatively high debt levels eating away at your net worth.
A high debt-to-equity ratio also indicates a riskier financial situation for you personally. For example, if your income situation changes due to job loss, unexpected expenses, or other financial hardships, it becomes harder to service all that debt since you don’t have much asset equity to lean on. That could potentially lead to missed payments, defaults, or even bankruptcies.
When does your debt-to-equity ratio really matter?
Checking your personal debt-to-equity ratio becomes very important any time you are taking on new credit from a lender. That could include situations like:
- Applying for a mortgage
- Getting a new car loan
- Opening additional credit card accounts
- Refinancing existing loans
- Applying for personal loans or lines of credit
Lenders will calculate your debt-to-equity ratio, among other factors, when determining your creditworthiness and qualifications for the new loan or credit line. If your ratio is very high because you’re overextended on debt already, that’s a red flag that you may have trouble making payments on the new debt as well.
Other times the debt-to-equity ratio comes into play? If you’re going through a divorce and dividing up debts and assets. Or if you’re having issues paying bills and considering options like debt consolidation or even bankruptcy.
Having a high ratio could limit your available credit, make loans more expensive due to higher interest rates, or potentially make lenders deny you outright. So, it’s wise to keep tabs on your debt-to-equity ratio, especially before applying for new loans or credit.
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The bottom line on debt vs. equity
Nobody likes looking at their financial picture through the lens of spreadsheets and complex ratios. But taking a quick look at your personal debt-to-equity ratio can provide a simple gut-check about whether you have too much debt weighing you down.
If the ratio is reasonable and under 0.5 or so, great! You have debt under control compared to the equity in assets like your home. But if your debts start dwarfing your assets, over a 0.8 or 1.0 ratio, that’s a flag to rein in your debt load and increase that equity position.
It’s a good idea to calculate your debt-to-equity ratio at least annually as part of your overall financial health checkup. Think of it as an easy way to measure the dreaded “owe” versus the comforting “own” side of your personal balance sheet.
Need help getting your debt under control?
If you have $10,000 or more in unsecured debt, JG Wentworth might be able to help. We’ve helped countless people reclaim their financial balance through our Debt Relief Program. If you’re contending with a high debt-to-equity ratio, consider these program perks:*
- One monthly program payment
- We negotiate on your behalf
- Average debt resolution in as little as 48-60 months
- 24/7 support
- We only get paid if we settle your debt
Calculating your debt-to-equity ratio isn’t difficult, so why should improving it be? Speak with one of our dedicated debt resolution specialists today to see how we can help. After all, when you improve your ratio, you improve your ability to achieve your financial goals.
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* Program length varies depending on individual situation. Programs are between 24 and 60 months in length. Clients who are able to stay with the program and get all their debt settled realize approximate savings of 43% before our 25% program fee. This is a Debt resolution program provided by JGW Debt Settlement, LLC (“JGW” of “Us”)). JGW offers this program in the following states: AL, AK, AZ, AR, CA, CO, FL, ID, IN, IA, KY, LA, MD, MA, MI, MS, MO, MT, NE, NM, NV, NY, NC, OK, PA, SD, TN, TX, UT, VA, DC, and WI. If a consumer residing in CT, GA, HI, IL, KS, ME, NH, NJ, OH, RI, SC and VT contacts Us we may connect them with a law firm that provides debt resolution services in their state. JGW is licensed/registered to provide debt resolution services in states where licensing/registration is required.
Debt resolution program results will vary by individual situation. As such, debt resolution services are not appropriate for everyone. Not all debts are eligible for enrollment. Not all individuals who enroll complete our program for various reasons, including their ability to save sufficient funds. Savings resulting from successful negotiations may result in tax consequences, please consult with a tax professional regarding these consequences. The use of the debt settlement services and the failure to make payments to creditors: (1) Will likely adversely affect your creditworthiness (credit rating/credit score) and make it harder to obtain credit; (2) May result in your being subject to collections or being sued by creditors or debt collectors; and (3) May increase the amount of money you owe due to the accrual of fees and interest by creditors or debt collectors. Failure to pay your monthly bills in a timely manner will result in increased balances and will harm your credit rating. Not all creditors will agree to reduce principal balance, and they may pursue collection, including lawsuits. JGW’s fees are calculated based on a percentage of the debt enrolled in the program. Read and understand the program agreement prior to enrollment.
JG Wentworth does not pay or assume any debts or provide legal, financial, tax advice, or credit repair services. You should consult with independent professionals for such advice or services. Please consult with a bankruptcy attorney for information on bankruptcy.