The Indebtedness sub-tab provides critical insights into an applicant's financial obligations and their ability to manage debt responsibly.
By using debt ratios, it is easier to assess whether an applicant is over-indebted. As a result, Loans Officers have a clearer perspective about an applicant's repayment capacity relative to their income.
This article explores the three debt ratios displayed in the Indebtedness sub-tab, explains how they are calculated, and outlines what the ratios reveal about credit risk.
Monthly Debt Ratio
The monthly debt ratio measures the proportion of an applicant’s monthly income used for repaying debts.
How it's calculated:
Total monthly payments on active accounts ÷ declared monthly income.
Key considerations:
Credit cards and overdrafts: These are not included. This is because there is no fixed payment. Payments vary monthly.
First Mortgages: These are excluded because rental payments are not included in the calculation. Including mortgages would create an unfair comparison between homeowners and renters.
Missed and defaulted payments: Are excluded because they no longer contribute active repayments. Furthermore including defaults may over-estimate indebtedness because these accounts are often passed to debt collectors who do not have a responsibility to update the credit file.
The monthly payments total is taken from the active accounts payment column.
In the example, below, there are three accounts with payment values but mortgages are excluding leaving £120 (unsecured loan) + £753 (second mortgage) = £873
Example:
Bob earns £1,500 per month and pays £500 toward debts.
Debt ratio: £500 ÷ £1,500 = 33%.Alice earns £1,500 per month but pays only £200 toward debts.
Debt ratio: £200 ÷ £1,500 = 13%.
Higher ratios suggest less disposable income. This can result in repayment difficulties, leading to higher lending risk.
Annual Debt Ratio
The annual debt ratio examines the relationship between total debt balances and an applicant's yearly income. This provides a broader, aggregated, view of their indebtedness.
How it's calculated:
Total debt balances (including loans, credit cards, and overdrafts) ÷ declared annual income.
Exclusions:
First mortgages: Treated like rent and excluded.
Utilities and regular bills: These are not considered debts.
In our example decision we can add the active balances and the current balances of the default accounts together to give us the total debt balances as so:
The total current balance of defaults is £33,375
The total of owed on active accounts (excluding first mortgage) is £75,640
£33,375 + £75,640 = £109,015
£109,015 ÷ £31,095 = 351%
Example:
Bob owes £20,000 and earns £24,000 annually.
Debt ratio: £20,000 ÷ £24,000 = 83%.Alice owes £10,000 and earns £30,000 annually.
Debt ratio: £10,000 ÷ £30,000 = 30%.
Higher annual debt ratios may indicate over-indebtedness, limiting the applicant's ability to take on additional credit.
Revolving Debt Ratio
The revolving debt ratio evaluates how much of their available credit an applicant is using on revolving credit accounts (e.g., credit cards, overdrafts). This ratio is a strong indicator of financial stress.
How it's calculated:
Total revolving balances ÷ total credit limits.
Example:
Alice has a £9,000 balance on credit cards with a total limit of £10,000.
Debt ratio: £9,000 ÷ £10,000 = 90%.Bob has a £1,000 balance with the same credit limit.
Debt ratio: £1,000 ÷ £10,000 = 10%.
Ratios exceeding 70% suggest reliance on revolving credit, often linked to financial strain or limited cash flow.
How Debt Ratios are derived
Debt ratios use data returned by the credit bureau and applicant-declared income. Here’s what contributes to these calculations:
Active accounts: Balances and payments are included in all debt ratio calculations.
Missed payments: Only balances are included (not payments).
Defaults: Balances are included; payments are excluded.
Excluded accounts: First mortgages and utilities are ignored as they are considered living expenses.
Example calculation:
An applicant earns £2,500 per month (£30,000 annually).
Balances: £18,897 (active accounts).
Payments: £403 (active accounts).
Monthly debt ratio: £403 ÷ £2,500 = 16%.
Annual debt ratio: £18,897 ÷ £30,000 = 63%.
Why this matters
Debt ratios are critical indicators of financial stability and repayment capacity. They help identify:
Applicants under financial strain: High monthly or revolving debt ratios may signal difficulties managing current obligations.
Over-indebtedness: Elevated annual debt ratios could indicate limited room for new credit.
Healthy credit behaviours: Low ratios often reflect better financial management and reduced risk.
By understanding and applying these insights:
You can assess lending risk with greater precision.
Make fair and consistent decisions based on reliable metrics.
For a detailed breakdown of other credit indicators, see our guides on Credit Profiles and Risk Assessment