How Much Debt-to-cash Ratio Should You Ideally Have? (Guest Post)
How much debt-to-cash ratio should you have for securing your financial life? Tough question to answer since we need both cash and debt in our life. Isn’t it?
Cash is used as a denominator to measure financial security. If you don’t have cash, you’re screwed. You can’t always depend on your credit cards and home equity during a financial crisis. The equity could disappear any minute. If you use a credit card to solve your immediate debt problems, you would have to pay a high-interest later. It’s like giving yourself a severe punishment.
Too much debt can ruin your financial life. Cash is the only safety net.
During the recession, many people got their heads blown off due to acute debt problems. Desperate time calls for desperate measures. Some people enrolled in a debt reduction program to get out of debt. Some people filed bankruptcy to pay off their debts. The situation wouldn’t have been that worse if they had cash in their wallet.
How much debt-to-cash ratio is good?
Let us find out how much debt-to-cash ratio you should have.
1. Having cash more than your debt: This is a great position to be in. You’re leading a healthy financial life. You’re less likely to be in a financial crisis. However, buy a health insurance policy, auto insurance policy, and liability insurance as per your affordability.
2. Having 100% debt-to-cash ratio: This is also not a bad position to be in. It’s like you have a $200,000 mortgage and $200,000 in your savings account. You’re also less likely to be in a financial problem. There is a great probability you won’t have to sell a property due to financial crunch. Try to have as many income streams as possible to increase your financial security.
1. Having a debt-to-cash ratio below 600%: You should have a fixed income every month. You should have a high-profile job or a business where your income would increase over time. You have to work for a long period. So forget about early retirement. There is no scope for that in your life.
A typical example of a moderate debt-to-cash ratio
You owe $450,000 on your home loan, $100,000 on student loan and have $150,000 in cash.
2. Having a debt-to-cash ratio between 600% and 1000%: Have you bought a new apartment? Have you made a huge down payment on your house? Are you left with only $40,000 in your savings account and $400,000 mortgage? In that case, you shouldn’t worry too much. This is a temporary situation. You can overcome it. You can rebuild your cash-reserve. Just do a part-time job or start a side business.
1. Having a 1000% debt-to-cash ratio: You’re at a great financial risk when your debt is 10 times more than your cash. You can be in a great financial crisis if your income drops due to some reasons. Your income should be extremely high and you have to manage your finances carefully.
A typical example of high debt-to-cash ratio
You make $300,000 every year. You have 3 massive student loans and 2 mortgages on your shoulder.
What should be your ultimate financial goal?
Your ultimate financial goal should be to get out of debt without running out of cash. You should try to preserve your cash reserve. There are several ways to pay off debt without running out of cash. Some of them are explained below.
- You can negotiate a lump sum settlement with your creditors. The catch is you’ll pay less than what you owe. You can negotiate on your own or hire a good debt negotiation company for settling your debts.
- You can develop a new website and start offering paid services to potential clients for increasing your cash reserve. If you’re a web developer, you can develop user-friendly and visually appealing websites for your clients to accelerate your income. Use the money for paying off debts.
- You can create a budget and start living frugally to reduce unnecessary expenses. You can use this amount for paying down your debts.
- You can work hard and ask for a hike based on your exemplary performance. If you can get a good hike, then you can easily make extra payments to your creditors every month.
Don’t incur too much debt in your life because you’ll be ruined. If you really have to, then take on debt for buying appreciating real estate properties. Even if there is a financial crisis, you should be able to fetch a good amount from rents.
Try to maintain a ‘no debt’ position since this may help you lead a comfortable life even after your retirement.