What’s a Good Debt Score? Debt Score is a proprietary approach developed by savvymoney.com to help borrowers understand for the first time how much debt is appropriate for their age, income, and educational level. To understand your Debt Score, you need to understand the idea behind the debt to income ratio and how it is evaluated. Raw Debt Score: Debt Score shares some similarities with the Debt-to-Income (DTI) metric long used by mortgage lenders and starts at a similar point, by computing basic debt to income scores for various debt categories.
Graded Debt Score: Lenders have long used traditional rules of thumb to assess borrowers’ DTI. Traditionally, 28% has been considered the gold standard maximum for housing expenses (mortgage payment, HOA, taxes, insurance) and 36% the gold standard for total DTI (adding together all your debts – mortgage, credit card, auto, student, and other legal obligations). Although rules of thumb can be useful, in this case they can mislead or even do harm. For instance, the same DTI ratios might not be appropriate for someone who’s 64 as someone who is 32. Credit card and other short term debt should be paid off much sooner in life so that you can move out of debt and start building assets. Evaluating Your Personal Debt ScoreLet’s look at each element of your debt score to understand how you grade can be impacted by your age, income, and other factors. We’ll lay out how your ideal debt payment target should change over time as you age. You can evaluate where you stand by comparing your score relative to the targets for your age. Housing debt: Housing debt costs (mortgage, insurance, HOA, taxes) is a significant investment and for many people is one of the major sources of investment. Because of this, it’s critical that it be paid off by the time you retire, as doing so will reduce your housing expenses that you’ll have to pay with fixed retirement income. Housing debt payments should max out at 28% of your income and decline slowly over time as your income grows but your mortgage payment stays constant. Later, in your 50s or 60s, you should pay off your mortgage and will only have recurring property taxes and HOA fees.
Total Lifestyle Debt: Your lifestyle debt is the types of debt and obligations that you incur outside of your mortgage. It includes credit card, auto debt / leases, student debt, and child support and alimony. Generally payments toward this debt should be less than 8% of your income. However, this percentage should come down rapidly as you grow older. Intuitively, you should be moving away from consumer debt and into a phase of asset building as you prepare for retirement and other long-term financial goals.
Student Debt: Student debt is an investment in future earnings, but one that can put serious strain on a budget. Because it can increase earnings, if you finish your college degree, it’s appropriate to allow your debt payments to increase slightly, but the student debt should be paid off within 10 years.
You can understand how healthy your debt load is on these metrics by comparing your raw score to the targets for your age. To calculate your Debt Score, click here. |
