If you plan to carry out a credit consolidation or carry out an audit of your budget, the first step is to calculate your debt ratio. You can perform this calculation before operation and after operation for example. This indicator conditions the acceptance of your request by the lender, but also determines your borrowing capacity and the conditions that you can negotiate.
What is the debt ratio?
How much can you spend on a new loan? To find out, you must calculate your debt ratio and your financing capacity.
The debt ratio represents the part of your monthly income consumed by the repayment of your various outstanding loans , whether they are consumer loans or a mortgage.
The generally accepted percentage is 33%: this figure corresponds to the limit established by banks and specialized financial institutions to decide whether or not to grant the requested funding. It is not imposed by any legal rule, but is in common use.
Also, depending on the criteria specific to each credit institution, as well as the income and charges which it takes into account in the calculation, your file may be granted by a lender, but refused by a competitor if it judges your profile too risky.
Why calculate your debt ratio?
Calculating your debt ratio is essential upstream of any loan application, or to assess the interest of a possible loan buyout. When debts accumulate and start to weigh on your daily life, or when you can no longer pay your monthly payments, performing this small calculation allows you to think about possible solutions .
For example, when your debt exceeds the accepted limits and causes real financial difficulties, the grouping of loans is likely to improve your budgetary situation.
How to calculate your debt ratio?
Calculating your debt ratio means determining the total weight of your monthly payments compared to your total budget . To do this, you will establish a complete diagnosis of your finances by including all your fixed charges in order to have a precise idea of your “remainder to live” when all the direct debits have passed. All these parameters are indeed taken into account in the study of the bank.
Step 1: Your monthly income
- Take the taxable base which appears on your last tax assessment.
- Add the amounts shown on your last 3 payslips.
- Add these two amounts and divide it by 15.
The result corresponds to the income that the bank or credit institution uses for its calculations.
In the calculation, the following income, considered as fixed, is always included :
- Your net wages (including any contractual bonuses or 13 th month);
- Your non-salaried professional income (benefit of farmers, traders, artisans and liberal professions);
- Support payments that you collect by court order;
- Your other pensions: retirement, disability, etc.
Specific income, which lenders recognize differently or exclude:
- Commissions (this is the case for salespeople for example);
- Family allowances, particularly when they are not received for the entire period of reimbursement envisaged;
- Housing allowances. When added to net income, they lower the rate. But if they are directly subtracted from the rent, it is the “remainder to live” which increases.
- Land income. They are subject to a reduction coefficient applied by the bank to compensate for any absence of rent. In addition, when this income is associated with a loan, it can be subtracted from the corresponding monthly payment by certain lenders while others will add it to the net income.
On the other hand, certain incomes appearing on your pay slips are excluded from the calculation because they are too irregular:
- Exceptional premiums;
- Professional allowances.
Step 2: The monthly payments for your current loans
List precisely and exhaustively all the loans that you are repaying (mortgage, consumer loan, personal cash …). Do not try to hide certain elements from the lender, at the risk of being refused the requested credit, but also of being put on a blacklist of borrowers. Furthermore, the finding of a false declaration gives the bank or the credit company the right to cancel a credit already accepted.
Gather the amortization tables for each of the loans on your list, with the exception of a possible mortgage intended to finance a rental investment. In the “monthly payments” column of each table, note the amount entered and add them up.
Note: if you are missing an amortization schedule, you can claim it free of charge at an agency of your bank or financial institution, or request it by email, or, if the service is offered, the download from the lender’s website.
Step 3: Your debt ratio
Depending on whether you have a rental investment or not, you will have to perform your calculation in 2 steps or in one.
- Calculate your debt ratio excluding rental investment according to the following formula (using the results obtained in step 2):
Amount of monthly payments / Amount of monthly income x 100
- Calculate the debt relating to your rental investment according to the following formula (based on the income compensation method):
[Loan monthly payments – (Gross rent × 70%)] / Amount of monthly income
- Add the two debt ratios obtained
- Calculate the debt ratio of the new loan according to the formula:
New loan monthly payments / Income
Why is the maximum debt ratio accepted by banks generally 33%?
The limit of 33% allowed for the debt ratio is not a regulatory rate, but lenders consider that it is not reasonable for a household to go into debt beyond 33%. In addition, beyond this maximum, the risk becomes too great for the banks, which fear unpaid bills.
It is also to guard against this that the banks do not limit themselves to the level of debt to make their decision. They carry out an in-depth study of the borrower’s profile and assign it a score (the “scoring”), notably on the basis of the “remainder to live” and the “family quotient”.
However, banks can revise it up or down, mainly depending on the “remaining to live”. For a household with high incomes, the bank can accept a higher level, provided that its resources allow it to cover all its other current expenses. Conversely, for a borrower with modest or irregular income, lenders will not admit a threshold higher than 30%.
You can also decide for yourself to reduce your debt level , especially for a mortgage. Indeed, as you commit to the long term, a debt ratio of 30% at the most preserves your ability to finance new projects over the years.
What if your ratio far exceeds the 33 or even 40% mark?
You have two options: consider buying back credits to reduce your monthly payments or request a “loan smoothing”, an operation which consists in lowering the monthly payments on a loan while waiting to settle your current loans.