Debt ratio, also known as debt to asset ratio, is one of the most accurate indicators of an individual’s or company’s financial health. It links your liabilities to your ability to pay off those liabilities.
Lenders such as banks and licensed moneylenders look closely at debt ratio when you apply for a loan, mortgage, or credit card. Personal loan normal income applicants should know how to calculate this figure as well as how to improve it.
Calculating Debt to Asset Ratio
The first step to calculate your debt to asset ratio is to calculate your total debts.
Debt includes long-term liabilities, including your total mortgage figure (principal and interest), vehicle loan, credit card debt, personal loans, and overdrafts. Be careful not to confuse expenses with debt in this step. Living costs like food, entertainment, and utilities should not be included in your total debts.
The next step is to calculate the total value of your assets.
Assets should include the total of all the sums you have in different bank savings and current accounts, fixed deposits (including the accrued interest), cash in hand, the market resale value of any vehicle(s) that you own, your gross income (before taxes and other deductions), stocks, shares, and other investments.
The final step is to plug these two figures into the debt to asset ratio formula:
Debt to asset ratio = (Total debts) ÷ (Total Assets)
If the value of your assets is greater than the value of your debts, the figure you will get will be less than 1. Conversely, a figure greater than 1 means that you have more debt than assets.
The Perfect Debt to Asset Ratio
Most people who have managed their debts and expenses responsibly will end up with a debt ratio that is around 0.5. This means that they have twice as much in assets as they do in liabilities. When you make a personal loan normal income application, lenders usually want this figure to be no higher than 0.6.
That does not mean that they will reject your application if the figure is higher, only that you will not be eligible for more beneficial terms. Borrowers with a debt to ratio figure around 0.3 will get the best deals. This usually includes lower interest rates, longer repayment periods, lower monthly instalments, and even a waiver of some fees and penalties.
Is Zero Debt Good?
If assets are good, debt is automatically bad, right? Not quite.
A strong debt to asset ratio is undoubtedly a positive when you apply for a personal loan normal income. On the other hand, banks and legal money lenders look deeper than the surface.
For example, someone who has just finished school at age 18 would ordinarily have no debt. That does not necessarily make them the ideal borrower. Because of a lack of familiarity and experience with loans and credit cards, that individual could be a potential defaulter. Lenders are cautious about lending to such people.
Compare that to someone five years older. This individual usually has some credit card debt and perhaps a personal loan that they are paying off regularly. To lenders, this person has demonstrated an understanding of their financial obligations and a willingness to play by the rules. Even though they have existing debt, lenders feel safer approving their credit applications over the 18-year-old’s.
So a total debt value of zero is a red flag, and not something to aspire towards. A range of debt is one of the factors that is considered when assessing your credit score. People who maintain several credit cards, and have home loans and vehicles are considered better borrowers and have higher credit scores.
Other Factors for Loan Approval
So, can a normal income earner get a personal loan just with a low debt ratio? Usually, yes, but there are other factors that come into play.
A lender will also look at your previous debt history, including bankruptcies. For example, someone who has just completed a DRS (Debt reclamation Scheme) order may have a very low ratio. However, a record of the debt remains on their credit report and lenders may be reluctant to get involved.
Another important factor is employment. Since your income plays a significant part in your debt ratio, you could have a good ratio just before you lose your job. When you apply at a lender, though, the lack of employment is more significant than the debt ratio figure that exists on paper.
Improve your chances of loan approval by maintaining a good balance between debt and assets, operating at least two credit cards, and also having a home and/or vehicle loan.