When making lending decisions, credit providers assess a consumer’s debt portfolio in a number of ways to determine the credit risk.
When making lending decisions, credit providers assess a consumer’s debt portfolio in a number of ways to determine the credit risk. These include amongst others, understanding the consumer’s affordability in terms of their debt to income ratio, as well as assessing their recovery risk in their debt to asset ratio.
Understanding and unpacking your debt profile, will therefore better equip you in managing and paying off this debt as well as presenting a more favorable position to credit providers.
When assessing a consumer for credit, credit providers will not only assess a consumer’s credit report and score, but will also look to understand their affordability. A good way to assess your affordability is to work out your debt to income ratio. In summary this is your monthly debt commitments versus your income, such as your salary as well as other ongoing income streams.
To work out your debt-to-income ratio, add up all your monthly payment commitments– school fees, rent, car repayments etc. Discretionary expenses like groceries and entertainment aren’t included in this calculation. Divide this by your net monthly salary to get your debt-to-income ratio.
Subscribers of TransUnion’s monthly and annual subscriptions, can make use of the Debt Analysis Tool available on the website, to quickly determine their debt to income ratio using data in their credit report. The result can then be compared against our ranges, being:
• 0 to 20% is considered good
• 21 to 40% is evaluated as fair
• 41 to 60% is seen to be at risk
• 60%+ can be considered over extended
Another aspect credit providers will assess when making a lending decision, particularly for larger credit extensions such as a home loan or vehicle finance, is the consumer’s debt to asset ratio. You can work out your debt to asset ratio by dividing your total debt by your total assets. Simply put, it calculates how many of your assets you will have to sell to cover the cost of your debt. The right ratio is more complex to determine as it depends on a number of factors like the type of debt and life stage of the individual. However, if you have significantly more debt than assets, you may be considered a risk to creditors.