Debt-to-income ratio is a key indicator used by banks and credit institutions to assess your borrowing capacity. It represents the portion of your monthly income that is dedicated to loan repayments. A high debt-to-income ratio can limit your borrowing options and expose you to the risk of over-indebtedness.
In this detailed article, Optimhome explains why it is so important to know your debt-to-income ratio and how to calculate it, to help you better prepare before applying for a mortgage.
Why Calculate Your Debt-to-Income Ratio?
Calculating your debt-to-income ratio is essential for several reasons. On one hand, it allows you to assess if you can consider a mortgage without jeopardizing your financial stability. On the other hand, this calculation is also a crucial criterion for banks, as it helps them determine if you are a creditworthy borrower and assess the feasibility of your home-buying project.
Preventing Over-Indebtedness
The debt-to-income ratio helps you measure the portion of your income already committed to financial obligations. Generally, it is recommended not to exceed a 35% debt-to-income ratio to avoid the risk of over-indebtedness. Exceeding this threshold can make managing your daily expenses difficult, especially if you encounter unexpected expenses.
Obtaining a Mortgage
Banks use this criterion to assess whether you are able to repay a new loan for property purchase without putting your finances at risk. A high debt-to-income ratio may lead to a loan rejection or a reduction in the amount you can borrow.
How to Calculate Your Debt-to-Income Ratio
Calculating the debt-to-income ratio is simple: divide the total amount of your monthly financial obligations (existing loans, rent, alimony, etc.) by your monthly income, then multiply the result by 100 to obtain a percentage.
The formula is as follows:
Debt-to-Income Ratio = (Monthly Fixed Expenses / Monthly Income) * 100
For example, if you have fixed expenses of €1,500 and a net monthly income of €4,000, your debt-to-income ratio would be:
Debt-to-Income Ratio = (1500 / 4000) * 100 = 37.5%
This ratio slightly exceeds the recommended 35% limit, which could pose difficulties in obtaining a loan for purchasing a property.
Which Expenses to Include in the Calculation?
To obtain an accurate debt-to-income ratio, it is important to properly identify all fixed expenses to include in the calculation. These include:
● Your loan repayments (mortgages, personal loans, auto loans, etc.),
● Your rent payments if you are a tenant,
● Any alimony payments,
● Regular charges such as loan insurance.
The income taken into account generally includes:
● Your net salary,
● Property income,
● Any pensions or allowances received,
● Stable benefits (e.g., family allowances).
Variable expenses (like utility bills or food expenses) are not included in the debt-to-income ratio calculation.
What to Do if Your Debt-to-Income Ratio is Too High?
If, after calculating your debt-to-income ratio, you realize it is too high (over 35%), there are several solutions to reduce it and proceed with your home or apartment purchase.
Consolidating Your Loans
Debt consolidation is an effective solution to combine all your loans into one, at a single rate. This can reduce the total amount of your monthly payments, thereby lowering your debt-to-income ratio. Credit institutions will generally offer an extended repayment period, allowing for lighter monthly payments.
Increasing Your Income
Another option is to look for ways to increase your income. This could include renting out a property, finding a new source of additional income, or even requesting a salary increase. However, these solutions may take time to implement.
Reducing Your Fixed Expenses
If your current fixed expenses are too high, you may try to reduce them by renegotiating some of your costs, such as insurance contracts or subscriptions. You may also consider paying off some loans early, if your finances allow.
Tools for Simulating Your Debt-to-Income Ratio
Many online calculators are available to help you quickly and accurately calculate your debt-to-income ratio. These tools are generally easy to use: simply enter your income, fixed expenses, and the calculation is done automatically. Some simulators, like the one offered by CAFPI, even allow you to simulate multiple scenarios to see the impact of new expenses or future loans on your debt-to-income ratio.
These simulators give you the advantage of better anticipating your borrowing capacity before submitting a loan application. This way, you present yourself to banks with a clear and realistic view of your financial situation, which can improve your chances of obtaining a mortgage for a property purchase.
Why Is the Debt-to-Income Ratio So Important for Banks?
Credit institutions pay close attention to the debt-to-income ratio to minimize the risks associated with clients becoming over-indebted. A high ratio often indicates difficulty managing personal finances, which increases the risk of default. For this reason, most banks refuse to grant a loan if the debt-to-income ratio exceeds the 35% limit. However, it should be noted that banks may waive this recommendation in 20% of financing applications.
Did you know? Banks also consider other factors in assessing a borrower's creditworthiness, such as job stability, type of employment contract (permanent or temporary), and banking history.
Conclusion
Calculating your debt-to-income ratio is an essential step before any mortgage application. It not only helps prevent over-indebtedness but also prepares you better for loan negotiations with banks.
By staying below the 35% threshold, you maximize your chances of obtaining a loan under favorable conditions. If your debt-to-income ratio is too high, solutions like debt consolidation or reducing your expenses can help you balance your financial situation. Don’t hesitate to use online simulators to guide you in this process and obtain an accurate estimate.
With your local Optimhome real estate advisor in France, get a professional property valuation for the property you want to purchase and benefit from their expertise to negotiate the right price with the seller, which can positively impact your loan amount and reduce your debt-to-income ratio.
