Looking for a loan? Why it's crucial to know your debt ratio

If you're looking for a loan you should always know your debt ratio beforehand. Why is it crucial? It tells you the chances of getting the money you need.
No matter how much money you want to borrow, a financial institution will always check your credit. The big question they want answered is: Will you be able to repay your loan? The first thing they’ll do with your application is calculate your debt ratio in order to get the answer. Doing the exercise yourself is easy and will give you a better idea of where you stand.

1. Determine your total gross monthly income—including wages, investments, alimony, child support and family allowance.
2. Calculate the total of your monthly payments for things such as rent or mortgage, car loan, other loans, credit cards, lines of credit and home insurance.
3. Divide the total amount of monthly payments by the total amount of your gross monthly income. Multiply the result by 100 to obtain your debt ratio.

For example, a household with a total gross monthly income of $5,000 and total monthly payments of $3,000 would have a debt ratio of 60 per cent (3000/5000 = 0.6 x 100 = 60%).

• Debt ratio of 30% or less: excellent
• Debt ratio between 31 and 36%: acceptable
• Debt ratio between 37 and 39%: critical
• Debt ratio of 40% or more: high

You probably already realize that with a debt ratio higher than 40 per cent, your chances of getting a loan are almost zero. If that is your case, don’t hesitate to talk with an advisor at a financial institution. An advisor can recommend solutions to rectify the state of your finances, such as debt consolidation.

In addition to debt ratio, financial institutions consider several other factors before granting a loan. These factors include:

• Job stability (how long have you worked for your employer?)
• Income stability
• Your credit score and rating (are you a good payer?)
• The type of loan requested (a mortgage is seen in a more positive light than a debt consolidation loan)

Before applying for a loan, check your credit report to make sure it’s accurate. If necessary, have any errors corrected.

If your debt ratio is at a critical level, you may be tempted to borrow money from a moneylender—you know, the kind who uses classified ads that promise to restore your credit rating in the blink of an eye. Beware! The costs may be exorbitant. Believe it or not, you’re much better off being patient. A certified financial advisor or a representative from your bank is the person to help you put your finances in order and restore the confidence of your creditors.