Debt Burden Ratios
Debt burden ratios are financial measurements used to assess an individuals or a business’ ability to pay off existing liabilities and debts. This ratio is a useful tool for lenders when it comes to gauging whether or not to grant a loan. It also helps businesses understand their ability to take on new debt with potentially higher interest rates. In order for these financial measurements to be accurate and valuable, it is important to have a clear understanding of how debt burden ratios work.
The first step in calculating debt burden ratios is to determine the debt amount. This includes any type of loan balance, such as mortgage loans, consumer loans, or business loans, credit card balances, and other types of debt. Once the debt amount has been determined, the next step is to calculate the debt service payment. This is the amount that the borrower will be required to pay each month to service the debt. The debt burden ratio is then calculated by dividing the debt service payment by the gross income of the borrower or business.
Debt burden ratios are typically expressed as a percentage, which reflects how much of the gross income is going toward servicing existing debt. Generally, a debt burden ratio of 30% or lower is considered acceptable, which means that no more than 30% of the borrowers gross income is going toward servicing their debt. This calculation can also be used to assess a businesss ability to take on more debt, as the ratio signifies how much of their gross income would be used for debt service payments.
It should be noted that there are other factors that creditors use in making their lending decisions, such as credit scores and income history. When creditors are reviewing potential borrowers, they will often look closely at the debt burden ratio. A higher debt burden ratio indicates that the borrower is more likely to default on the loan, which can put the lender at risk. Therefore, if a borrower has a high debt burden ratio, they may be able to decrease their chances of being denied a loan by increasing their monthly income or by paying off existing debt.
When creating monetary budgets, it is important to factor in debt burden ratios. It is important to understand that a loan should not be taken on if it will cause a debt burden ratio to exceed 30%. If a business or individual has a debt burden ratio that is higher than 30%, they should plan to pay off existing debt or find other ways to increase their gross income in order to be in a better financial position.
Overall, debt burden ratios are an important financial measurement that can be used to assess a person or businesss ability to take on more debt and manage their existing liabilities. It is important to note that loan payments should not exceed 30% of a borrowers gross income and that budgeting accordingly is important in order to keep debt burden ratios in check.
