My Debt Burden Ratio

The debt burden of an institution or an individual is the amount of mandatory debt payments that must be made for a given accounting period. Debt burden ratio is the relationship between this amount and the income or earnings of the indebted entity. The ratio is a useful metric in predicting loan repayment ability.

Debt Burden

Your debt burden is simply the sum of all periodic debt payments you must make. The monthly debt burden would be the amount of money you must pay to your creditors every month, while the annual debt burden would take into account all mandatory payments over a 12-month period. For a typical individual or family, the debt burden may include monthly minimum credit card payments, mortgage payments, car payments and other recurring bills from creditors, including payments you must make for consumer goods bought on credit, such as the $45 monthly payment for the plasma TV you bought with no money down.

Debt Burden Ratio

The debt burden ratio is defined as your debt burden divided by your after-tax income. If the total monthly debt payments are $2,500 and your take-home, after-tax pay is $5,000 per month, your debt burden ratio is 0.5, which, expressed in percentage terms, is 50 percent. The higher the debt burden ratio, the less of your income is "disposable," or available to spend as you wish. In the prior example, only half of your income is under your control, while the other half must go to mandatory payments.

Significance

The debt burden ratio primarily measures the likelihood that you can repay your existing loans. The lower the ratio, the easier it is for you to make your monthly loan payments, because they constitute a relatively small percentage of your income. The debt burden ratio is not a measure of how favorable your loans terms are. You may be paying an extremely high rate of 40 percent on your credit card debt. If, however, you only have only $1,000 in outstanding credit card debt, the monthly payment and your debt burden ratio likely will be low. When you apply for additional credit, this ratio is a critical factor considered by potential creditors. The lower the ratio, the easier it is to obtain new lines of credit.

Additional Factors

Although the debt burden ratio is a useful metric that is easy to calculate, it does not provide a full picture of your financial condition, unless additional factors are considered. One factor to be considered is your asset base, which is the value of your possessions as a given time. You may only be making $4,000 per month, which barely exceeds the $3,500 you must pay to creditors. But if you have several million dollars invested in gold and long-term bonds, you probably will have no problems making those monthly payments. An additional factor is how easily you can eliminate your loans. Your can eliminate a car loan by selling the car and paying off the loan with the proceeds from the sale, for instance. The same maneuver cannot be used to get rid of credit card bills, however.