It’s a good idea to calculate your debt ratio before meeting with your bank. Your banker will be able to tell you your borrowing capacity and assess the soundness of your application. All vital information before starting negotiations.
The “right” level of debt
There aren’t any specific legal obligations, but in general, banks won’t accept debt levels higher than 33%. In other words, if mortgage payments account for more than one third of your monthly income, banks take the view that there’s too great a risk of you not being able to meet monthly repayments.
The limit is in place to protect not only the financial establishments who provide mortgages, but also borrowers. Very often loans involve high costs, so to avoid financial problems and excessive debt, taking out too many of them is not advisable. Banks can face legal consequences if they are proved to have lent money to a borrower who does not have the financial wherewithal to meet the repayments.
Working out your debt level before meeting with your bank will give you more confidence. Calculating your borrowing capacity makes it easier to negotiate the interest rate, term and monthly repayments of your mortgage.
How is it calculated ?
Bank loans, consumer credit, loans from another private individual… your debt ratio takes into account all the loans you have taken out. To calculate your debt ratio, divide all those costs by the household’s income and multiply the result by 100.
Each bank’s “recipe” of income that must be taken into consideration is different. That explains why one financial institution may reject your application whereas another will grant you a mortgage. What is systematically taken into consideration for calculating your income is: net salaries, bonuses (assuming they are contractual) and, where your income is calculated over 13 months, the 13th month.
Some banks take family allowance into account in the calculation. Some include real estate revenue. Some lenders simply consider it as net revenue. Other banks, however, continue to treat real estate income slightly differently due to the risk of tenants defaulting on rental payments. Special bonuses and compensation relating to work (further to an occupational accident, for example) are, on the other hand, never included in the calculation.
Is it possible to go over the limit ?
The maximum debt ratio ceiling of 33% can be breached… on condition that the bank gets certain guarantees. Showing you’ve been managing a budget equal to the monthly loan repayments is one. Banks tend to be accommodating with lenders who are purchasing a main residence and whose monthly repayments are the same amount as the rent they were previously paying.
Good account management will also go in a lender’s favour. Any recent incidents of being overdrawn (whether the overdraft was authorised or not) will damage the chances of your application being successful, even if your debt ratio is no higher than 33%. On the other hand, banks look very kindly upon lenders who can show that they’ve been putting money aside for a while.
Higher earners are also well received, of course. A manager or qualified engineer just starting out, who will likely see their income rise, can easily negotiate a higher-than-average debt ratio. Banks may also consider whether the borrower will have sufficient left to live on. A monthly income of 10,000 euros and a debt ratio of 40% will leave 6,000 euros to live on. Enough to cover all a household’s costs, in certain cases, in the bank’s eyes.
Focusing only on debt ratio, therefore, does not give the whole picture. Obtaining a mortgage involves taking all a lender’s circumstances into consideration, especially what they will have left to live on, their borrowing capacity and their ability to manage their accounts.