The debt ratio is used by banks and financial institutions to study the creditworthiness of a potential borrower. This rate is the basis of a loan to determine the acceptance of the loan, but also the rate of credit.
In the broad sense, it is a percentage index, it assesses the proportion of revenue spent monthly on loan repayments and fixed costs.
The elements to take into account
In order to calculate the debt ratio, it is necessary to take into account:
- Income: this takes into account income of all kinds, namely net wages, allowances, pensions, annuities, rents received if this is the case;
- Fixed costs: these are mainly all loans contracted (consumption, real estate, auto, etc.), electricity bills, gas, water, and rents paid.
Calculation of the debt ratio for a loan
In order to calculate the debt ratio required for a loan, it is sufficient to divide fixed expenses by income. Then multiply the result by 100: this gives the percentage of the debt ratio.
For example, if a person earns $ 2,500 monthly, regardless of their income, and has to repay a loan of $ 500 a month, their debt ratio will be 20%: ((500/2500) x 10).
It should not be confused with the “rest to live”, corresponding to the difference between income and fixed costs. Nevertheless, these two notions are closely linked because they are essential for the financial organizations to decide to grant a loan.
In general, the debt ratio should not exceed the 33% rule. Beyond this rate, by accepting a loan application, the financial institution takes significant risks.
The special case of the family quotient
If a borrower has very low incomes, the family quotient is used to determine if he or she can acquire a credit. If this quotient is greater than 4500 $, it is easier to have a credit.
To calculate it, we first estimate the income after payment of the monthly payments. It is divided by the number of people in household (including children, each child represents ½ part, up to the 3rd represents a unit). We then multiply this income per person by 12, the number of months of a year.
For example, for a couple with a child who would earn 1200 $ after payment of the monthly payments, the income per person is 480 $. The family quotient is therefore $ 5,760. ((1200 / 2.5) x 12).
The household debt ratio
This is the rate taken into account in national statistics. To calculate it, we divide the total amount of credits awaiting repayment by households, by their income.
For example, someone who earns $ 50,000 a year. He still has to repay a credit of 30 000 $ in all. Its debt ratio will be 60% of its annual disposable income. This is below the national average of around 80%.
Conclusion on debt ratios
Thus, in the global sense, the calculation of the debt ratio makes it possible to inform the financial institutions about the risks of granting a loan or not.