Are your debt levels too high?

Do you have too much debt? Does your current level of debt make you uncomfortable? Have you asked yourself what this is based on? We all earn different incomes, our costs are not the same, our wealth varies – so what are you comparing to?

Debt is money that must be repaid to the organisation or person that loaned it to you in the first place. This includes a mortgage, a bank overdraft, or money owed to your sister!

To answer this question, you should check on two key measurements: debt-to-income ratio and credit utilisation. These are used by your lender when applying for new credit; the below assesses this question based on these two measurements.

This article, therefore, does not address your day-to-day debt management, more how your debt levels affect your risk and affordability.

Debt-to-income ratio

Your debt-to-income (DTI) ratio is the measurement mortgage lenders use to check your risk and affordability. Lenders use this to check you can afford to keep on top of your repayments.

It is a percentage that shows how much of your monthly income goes towards paying off your debts. Your debt-to-income ratio does not appear on your credit profile, but the information required to calculate it is collected upon application. You want the figure to be less than 45%.

Debt payments:

Include credit card payments, car loan payments, and an amount to cover the overdraft you may be living in. The overdraft amount should be the monthly interest payment plus 3% of the current overdraft balance. Do not include utility bills, subscription services or phone contracts.

Pre-tax income:

Take your annual salary and divide by twelve. If you are paid daily, multiply your day rate by 22. Include benefits, tips, and bonuses.

Sheree Example

Monthly debt payments – credit card £100 and a car loan £245

Monthly pre-tax income of £3,500

Sheree has a DTI of 9.8%, this is below the recommended 45%.

Credit utilisation

Credit utilisation is the second biggest measurement affecting your credit score. Your credit score is checked when you apply for credit and is used to determine acceptance and the terms offered.

It is a percentage showing how much credit you are using compared to your available credit limit. You want the percentage to be below 30%, or 20% if possible.

Credit balances:

Add all the balances on your credit cards together.

Credit limit:

Check the credit limits you have across all your credit cards and add together.

Michael Example

Credit card balances of £620, £450 and £6,500 (total £7,570)

Credit limits of £1,000, £2,500 and £15,000 (total £18,500)

Michael has a credit utilisation of 40.9%, this is above the recommended 30%.

How to improve

If you are reading this, you are likely to want healthy finances, low debt levels and an attractive profile. If, after reading the above, you assess your debt levels not to be good, follow the steps below to improve them.

  • Avoid taking out new debt
  • Review your personal budget and identify additional money to increase your debt repayments
  • Generate more money: get a new job or pick up a side hustle
  • Consolidate your debts or move debt to a 0% balance transfer credit card

Get started on improving your debt levels today, improve your credit score, risk profile and affordability.

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