When making lending decisions, credit providers assess a consumer’s debt portfolio in a number of ways to determine the credit risk.Get Your Credit Report
When making lending decisions, credit providers assess a consumer’s debt portfolio in a number of ways to determine the credit risk. These include amongst others, understanding the consumer’s affordability in terms of their debt to income ratio, as well as assessing their recovery risk in their debt to asset ratio.
Understanding and unpacking your debt profile, will therefore better equip you in managing and paying off this debt as well as presenting a more favourable position to credit providers.
What does your debt to income ratio look like?
When assessing a consumer for credit, credit providers will not only assess a consumer’s credit report and score, but will also look to understand their affordability. A good way to assess your affordability is to work out your debt to income ratio. In summary this is your monthly debt commitments versus your income, such as your salary as well as other ongoing income streams.
To work out your debt-to-income ratio, add up all your monthly payment commitments– school fees, rent, car repayments etc. Discretionary expenses like groceries and entertainment aren’t included in this calculation. Divide this by your net monthly salary to get your debt-to-income ratio.
Subscribers of TransUnion’s monthly and annual subscriptions, can make use of the Debt Analysis Tool available on the website, to quickly determine their debt to income ratio using data in their credit report. The result can then be compared against our ranges, being:
• 0 to 20% is considered good
• 21 to 40% is evaluated as fair
• 41 to 60% is seen to be at risk
• 60%+ can be considered over extended
How do your debts and assets stack up?
Another aspect credit providers will assess when making a lending decision, particularly for larger credit extensions such as a home loan or vehicle finance, is the consumer’s debt to asset ratio. You can work out your debt to asset ratio by dividing your total debt by your total assets. Simply put, it calculates how many of your assets you will have to sell to cover the cost of your debt. The right ratio is more complex to determine as it depends on a number of factors like the type of debt and life stage of the individual. However, if you have significantly more debt than assets, you may be considered a risk to creditors.
Take stock of the type of debt
As mentioned, the type of debt in a consumer’s debt portfolio is also a key consideration. Debt can be broadly broken down into two types ̶ secured and unsecured.
Secured debt is a loan that is granted against an asset, usually a house or vehicle, which is used as collateral against the loan. Simply put, if the borrower does not honour his/her payments over time, the lender can seize the asset and sell it to recoup their money. The interest rate on this type of debt depends largely on the credit rating of an individual, the more credit worthy a person is deemed to be the lower the interest charged.
With unsecured debt, such as credit cards and personal loans, there is no asset to act as collateral. If the borrower defaults, the credit providers has to take them to court to recoup their money. This type of debt usually comes with a higher interest rate to ameliorate the risk of the loan.
In general, having an excess of unsecured debt is seen as less favourable, when applying for credit.
Be strategic when paying off your debt
If you have additional funds available and are looking to pay off your debt sooner, as a general rule you should look to pay-off the debt that carries the highest interest rate. This is usually your unsecured debt such as credit cards and personal loans, but this differs greatly between consumers and each debt portfolio need to be assessed in its own right.
Many store cards allow interest-free credit windows, so try and pay off the total bill within the period and avoid interest charges. Don’t spend more on the card before you have paid off the total and try not to extend your payment period.
Don’t avoid credit providers if you find yourself in trouble
If you find yourself falling behind on, for example your credit-card payments, contact your credit provider to set up a payment plan. They will usually allow you to pay smaller instalments but may suspend your account and limit any further credit until the loan amount is paid off in full. This can be helpful if you find yourself falling into a credit trap where you are paying larger and larger amounts into your credit card, only to have to live off the card come month end because you’ve run out of money.
When looking at your overall debt repayments, pay off as much as you can each month, but makes sure you have enough liquidity to last you to the next pay day.
What is debt consolidation?
Debt consolidation is when you take out one large loan to cover several smaller loans. In other words, you consolidate all of your debt into one lump sum. It might sound counterintuitive, but if used wisely, consolidation can be an effective way to get yourself out of unmanageable debt.
Consolidated loans are usually longer term loans that come at a lower overall interest rate and lower monthly instalments. It is also possible to use, or extend, your home loan to consolidate debt, depending on your credit rating and how much of the loan you have already paid off.
A word of warning, however, because these are longer term loans the total amount you end up paying could well end up costing you more.
What is debt counselling and debt review?
Debt counselling and debt review is a legal process that was introduced with the National Credit Act (NCA). It allows over-indebted consumers a means to hang onto their assets and protect themselves from legal action from creditors. When entering into debt review a person allows a debt counsellor to obtain a court order on their behalf and to draw up a manageable repayment plan. The counsellor will liaise with creditors to renegotiate payment at lower interest rates.
It might sound like the ideal solution to an unmanageable debt situation, however it’s important to realise that there are downsides to debt counselling.
Firstly, it will cost you. Although the application fee for debt counselling is nominal, there are fees that will be worked into your payment restructuring. Debt counsellors are under a legal obligation to disclose the full cost of debt restructuring upfront. It’s important to shop around as not all debt counsellors fees are the same.
Importantly, it will impact your credit rating. You will be listed at all credit bureaus as being under debt review, and you will not be able to access any form of additional credit until you have paid up your restructured debt and are issued with a clearance certificate.
It’s also vital to ensure that the debt counsellor you choose is registered with the National Credit Regulator (NCR). If you choose an unregistered counsellor you may not be protected by law. To find a registered debt counsellor and learn more about the debt review process visit the National Credit Regulator (NCR).
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