Monday, July 29, 2013

What Is Insufficient Debt Capacity?

What Is Insufficient Debt Capacity?

When you apply for a loan, credit card or line of credit, the lender or credit card company will ask you a number of questions about your financial situation and look at your credit history. If they deny you, they may give you one of a number of reasons for denial. One of these reasons could be insufficient debt capacity.

Definition of Debt Capacity

    Debt capacity is the amount of debt you can conceivably take on in your current economic situation. Lenders are concerned with this because they realize that there is only so much debt that a person can handle. If prospective monthly debt payments exceed your disposable income levels, lenders will see you as a high risk, and they will probably deny you under the assumption that you would not be able to pay them back.

Contributing Factors of Debt Capacity

    Lenders determine your debt capacity based on various factors, such as living expenses, regular income and existing debt. If you have high levels of existing debt or high living expenses and your regular income is low, this means that your debt capacity is low. If you have low levels of existing debt or low living expenses coupled with a relatively high regular income, your debt capacity is probably high.

Debt Coverage Ratio

    Debt coverage ratio is a calculation that lenders make to determine debt capacity. They look at your expected income in the near future (minus living expenses and existing debt payments) and divide it by what you would be paying them for the debt you will incur. Credit card companies typically assume that you will have your credit card at its maximum limit. If this ratio is lower than 1.2, they probably will decide that you have insufficient debt capacity.

Increasing Debt Capacity

    If you are denied a credit card, loan or line of credit due to insufficient debt capacity, you can improve your debt capacity in the future by paying off your existing debts. The most basic way of doing this is by living in a more frugal manner, such that you have additional money with which to pay off your loans and credit cards. After significantly decreasing your existing debts, you may be able to get loans and lines of credit in the future.

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