The debt ratio is a specified value that allows banks to assess the creditworthiness of a borrower before deciding whether to grant them a loan. As such, there are several methods for calculating this debt ratio which differ depending on whether the borrower in question is an individual or a business.
The debt ratio for individuals
The banker calculates the debt ratio of an individual to find out if the latter will be able to repay the maturities relating to this credit. This is the reason why, the calculation of this debt ratio, in the same way as the ratio of the remainder to live, is necessary before the granting of a loan. This will allow the banker to determine the maximum amount he can grant to the borrower as credit.
To perform this calculation, the banker will need two indicators.
The first concerns the amount of fixed charges which the borrower pays each month such as the rent for tenants or the maturities of a mortgage or even consumption. The future maturities relating to the granting of this new loan must obviously be included in the fixed charges.
To obtain the debt ratio for individuals, the total amount of fixed costs will have to be divided by the amount of fixed income of the borrower. Thus, the debt ratio will have to be less than 40% for the banker to decide in favor of the borrower in order to grant him this credit. A loan whose repayment rate will depend, moreover, on this debt ratio. The higher the latter, the higher the credit repayment rate.
To understand your debt ratio:
- A debt ratio of less than 30% is excellent.
- A debt ratio between 30 and 35% is good.
- A debt ratio greater than 35% is acceptable, but should be monitored.
- A debt ratio greater than 40% could prevent you from receiving a loan (mortgage, car loan or student loan).
The debt ratio for companies
In companies, on the other hand, credit institutions will take into account other types of parameters to obtain a company’s debt ratio. For example, the participation of the shareholders of the company in question in taking risks related to its various activities.
The calculation of this debt ratio will involve the use of the term debt ratio which will be divided over the cash flow. This ratio should therefore be less than 4. As for the ratio of term debts to equity, it should not exceed 1.
The debt ratio is an important indicator!
So, before making your credit request to a bank, you now have the possibility of calculating your debt ratio by taking into account the different parameters inherent to your situation depending on whether you are an individual or a business.