What do Lenders Think About Your Financial Stability?

Written by Monica Sandler

Thursday, 18 September 2008 11:47

There are always two aspects to debt, good and bad. The good one is that debt allows you to accomplish things you wouldn't otherwise be able to accomplish. Naturally, it is good to have more access to credit funds when you need them. The bad one is that debt leverages your finances, and reduces your financial stability. Your monthly payments are locked, you have to spend money on interest, you have less financial flexibility, etc. The question is how do you choose the compromise? The answer becomes simple if you look at the indicator called debt ratio.

That's the number the lenders use to determine your creditworthiness. Debt ratio is the money you have to pay each month to service your debt divided by your monthly income. For example, if Joe makes $3,000 a month and has to pay $1,000 a month to creditors, his debt ratio is 33%. The meaning is that with Joe's last paycheck he will be able to cover his dues for 3 months.

Lower debt ratio is better because it marks low debt weight, higher financial stability, and better creditworthiness. Lenders think of values anywhere under 30% as good, and those exceeding 50% alarm an unstable financial situation. If you were to apply for a new loan, lenders will generally look at your would-be debt ratio and will only approve a new loan if it does not exceed these limits.

We normally recommend keeping debt ratio under 30%. If you ever go past it, you better have a solid goal in mind about

what you are trying to accomplish by taking so much risk
how long it will take you to return back under the 30% level.

We also recommend you work out a plan about what to do if for some reason you find yourself unable to carry on so much debt.

If your debt ratio is above 50% try reducing it immediately. Here are a few ideas about how to do it:

consolidating some of your debt
refinancing for lower rates
putting down collateral
extending the term of your loan

In most cases, extending the term of your loan will not save you money. It should be left as a last resort for a situation when financial risk is so large that you need an improvement of your financial stability at all costs. You can always (and should, if you can) contribute more than the minimum amount to your debt payments.

A low debt to income ratio along with a good credit standing, which is determined by timely repayment of debt, are both considered very favorable by lenders. Most often, a low debt ratio along with a good credit standing will entitle you to receive the best interest rates and in some cases provide less collateral. And most importantly, it signifies financial stability, which is the ultimate goal which Ameri-Financial has in mind for you.