The debt ratio is the calculation used to determine your ability to make a reliable repayment when you apply for a loan. Your financial institution will decide whether or not to grant you a loan based on this calculation.
Whether you are looking to finance a home purchase, a travel project or an investment, this calculation will be done. Therefore, it’s important to keep the ratio low enough to get your financial institution to lend you money. In other words, the lower your ratio, the higher your credibility with financial institutions.
To help you better understand what the debt ratio is, our financial recovery advisors answer some questions for you. Find out everything there is to know about the debt ratio, how to calculate it, and how it affects your loan requests.
Debt ratio: definition, threshold and calculation
What does the debt ratio represent? By definition, the rate represents the fraction of your income that is used only for the purpose of paying off your debts. Don’t make the mistake of confusing total debt with debt ratio!
How do you calculate the debt ratio?
Our experts will now present two situations explaining why the overall debt and the debt ratio are different.
- In household 1, the monthly debt is around $800/month. The household’s monthly income is around $3,000.
- Household 2 also has a monthly debt of approximately $800. In contrast, household two’s monthly income is slightly below $2,000.
The overall household debt is the same, but the impact of this debt is different. Obviously, a debt of $800 affects the financial situation of the household with the least income much more.
Calculate one’s ratio and repayment capacity
The debt ratio calculation therefore takes into account the total household financial situation. In the situations presented, the debt ratio of household 2 is higher than household 1. The reimbursement ability of household 2 is therefore more difficult than household 1.
Ideally, your ratio should always be less than 33%. Your debt repayment should therefore always represent less than a third of your total income. When you do the math yourself, remember to take into account all of your monthly obligations.
How to maintain a good ratio?
In order to maintain a good ratio, always keep your budget limits in mind. Credit is good, but you have to remember that it is loaned money. Before spending without calculating, consider your income.
It’s often the little expenses here and there that add up and inflate the bills. To maintain a good ratio it is therefore necessary to keep a watchful eye on our relationship with credit.
A ratio below 33% is considered excellent. Between 33 and 36 is still considered acceptable by financial institutions. However, if you find yourself above the 40% mark, applying for a loan will be more difficult.
If your debt ratio reaches 50%, you may have difficulty keeping your monthly obligations. Before cutting into expenses that are not calculated in the ratio (food, transportation, personal expenses, etc.), we strongly recommend you seek help. A financial recovery expert can help you find a solution to get you out of your debts.
Consult your financial expert to get out of debt!
Unfortunately, getting out of debt is one thing, not going back is another. If you need help finding your weak spots, it’s important to consult a financial expert.
The first step to keeping your financial situation in good health is to identify the sources of your problems in order to avoid finding yourself in debt again. With the help of an experienced advisor, you are putting the odds in your favor.
If you have any questions about the debt ratio, don’t hesitate to contact us! Our team is delighted to share with you.