A debt-to-equity ratio is a way of measuring if a corporation or group is being financed through debt or owned outright by funds/assets. Debt-to-equity ratios are commonly used and referenced in the financial world, and as such are important to understand. Knowing what is good and bad when it comes to debt-to-equity ratios can help keep groups financially secure long-term.
‘Good’ and ‘Bad’ Debt-to-Equity Ratios
Debt-to-equity ratios are calculated by dividing total liability (debt) by equity. A 1.0 or less is a safe or less-risky ratio to have. A number higher than 2.0 is thought to be less secure. However, a good debt-to-equity ratio does not guarantee that a business will be successful.
When it comes to a personal consumer’s debt-to-equity ratio, 80% is the limit for safe financial housekeeping. If your debt-to-equity ratio exceeds 80%, lenders and creditors are going to consider you a risk and may avoid extending you further credit or funding your loan.
Unfortunately, most young people find themselves in 80% territory when working to accumulate assets. Most people do not begin their adult lives with significant savings, and often buy homes with a minimum down payment. This common transaction gives almost every young family a high debt-to-equity ratio. Over time it is possible to reverse a high debt-to-equity ratio by paying down outstanding loans and carefully avoiding new debts while carrying large existing debts.
This is a GREAT example of why we recommend our debt relief program to anyone overwhelmed by existing debts, because we don't believe people should take on more debt to pay off existing debt! Typically, new loans carry higher interest rates and have little to no advantage over simply consolidating the debt into a relief program and negotiating a better rate.
Because of the varying circumstances in which different industries operate, a high debt-to-equity ratio does not always spell doom. The ratios are used by investors to decide the risk of investing in any given company, keeping in mind the risk the company itself has accumulated. Diverse industries and situations make it difficult to determine the health of a business using equity ratios alone. A good debt-to-equity ratio can be described as a company that has low liabilities compared to assets, while a bad ratio can be understood as a company that operates in debt. It is considered safer to be financed by equity and income, rather than debt- but this principle can be overlooked, depending on the industry.
Some people may want to invest in a company that has more debt than others, as long as the company in question has a good history making wise financial decisions, or is very capable of generating income to repay debts. In addition, some industries simply have a higher debt-to-equity ratio and so cannot be faulted for the financial ratio outcomes of the business.
In the end, having a high debt-to-equity ratio whether you’re a large corporation or an individual person can cause stress and struggle. If you yourself are struggling with consumer debt, allow Golden State to help you. We have realistic plans that can help you consolidate your debt and work towards becoming debt-free. See how we can help you live a life more financially free.
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