Want to take a vacation in Europe, buy your first condominium, or just make an unexpected purchase? In short, you have new projects in mind; but before getting a loan, have you thought about checking your debt ratio? Few people do it, and yet it is important to know this parameter before considering applying for a credit, regardless of the amount.
Find out what debt ratio and existing methods are for knowing where you are in terms of debt.
What is the debt ratio?
The debt ratio (or ratio of indebtedness in banking language) is a unit of measurement that makes it possible to evaluate your theoretical repayment capacity of a loan. It allows you to compare the total income collected monthly with the total amount reflecting your monthly financial obligations.
The purpose of this calculation is to know how you are perceived by financial institutions. In other words, it will allow you to know if you qualify for the credit, and if so, what are the possible amounts.
What is the importance of knowing him?
If this date still seems superfluous, they are very important to understanding your budget and allow you a better management of your money. They allow you to:
- Avoid over-indebtedness, a situation that tends to increase in Canadian homes, according to recent studies;
- Whether you have the opportunity to apply for a new credit;
- To know, if necessary, your capacity for refund and the delays of refunding which you will be able to propose at the time of your request.
There are three tranches representing your financial situation:
- Excellent: if your debt ratio is below 30%
- Good: if your debt ratio is between 30% and 40%
- Bad: if your rate is above 40%
Although these rates are just indications, it allows you to better situate yourself and know how much leeway you have in debt.
How to calculate your debt ratio?
To do this calculation, you will not necessarily have to call your accountant. Simply add up each of your regular payments, such as your rent or mortgage payments, insurance, credit card payments and loans, by dividing by your gross monthly income (before taxes and deductions).
The calculation of the debt ratio is therefore as follows: Total monthly household payments / Total monthly household income X 100
The simple calculation quoted above will allow you to obtain the percentage of indebtedness you are currently facing.
Note that expenses such as your electricity bill, telephone, transportation and grocery bills do not count when calculating your debt ratio, these expenses are not considered debt generators. That being said, calculating the average of this type of expenditure will still give you a better idea of your overall monthly budget, so it is advisable to take them into account so you do not have to know the bad experience of a failure to pay.
The debt ratio: a fact to know
Thus, if you find yourself in one of the situations described in the beginning of the article, being aware of your debt capacity will allow you to think more serenely about your projects, and to be in possession of all important data to a good control of your finances.
And if the idea of a vacation always tempts you, but you are a little more limited than expected, why not contact us?