What is the debt ratio calculation? The ratio, or debt rate, represents the fraction of your income which is used only for the repayment of debts, loans or credits. As a general rule, it is recommended to keep your debt ratio below 33% of your income. Find out what is the purpose of calculating the debt ratio.
What is the purpose of calculating the debt ratio?
The debt ratio calculation is used to know your repayment capacity when you apply for a loan from your financial institution. Whether it is to finance an investment or obtain a mortgage, your financial institution will calculate your debt ratio before granting you a loan. The debt ratio is established by comparing your gross monthly income to the amount of your monthly financial obligations.
Warning ! Do not confuse your debt ratio calculation for the notion of debt. For example, if two households have the same amount of debt, this does not mean the debt ratio calculation result will be the same. If household 1 has debt of $300 / month and income of $1,000 / month, the rate will differ from household 2 which has debt of $300 / month, but income of $2,000 / month. The impact of debts in household 1 is higher than in household 2, so the debt ratio calculation will be different, even if the debt is the same.
However, calculating your debt ratio gives you a good idea of your current financial situation.
What if my debt ratio calculation is too high?
A good debt ratio is generally below 30%. For financial institutions granting loans, a ratio of 30 to 36% is also well seen. However, when your debt ratio calculation reveals a ratio greater than 40%, your loan request may be compromised.
In addition, if your debt ratio is greater than 50%, there is a good chance you cannot pay certain expenses not included in the debt ratio calculation such as food, personal expenses (other than those charged to your credit cards), transport and others. In this case, we strongly recommend you use the service of a financial recovery advisor. The main role of a financial recovery advisor is to help individuals and businesses get out of debt.
Some people experience transient financial trouble, others have longer-term financial problems. But, whatever the context, it is important to diagnose the weaknesses in your financial situation to start fixing it. With the help of an experienced financial advisor, you will be able to regain control over your finances and regain your financial stability.
For any questions regarding the debt ratio calculation, contact us. Also, do not hesitate to make an appointment for a free and confidential meeting in one of our offices located in Montreal, Pointe-Claire, Laval and Longueuil. We are delighted to welcome you and answer all your questions.