Home' Trinidad and Tobago Guardian : May 10th 2015 Contents Along with your net
worth and your
monthly cash flow,
your debt servicing
ratio is another impor-
tant number that you
need to know to assess
your financial health.
Simply put, knowing your debt service ratio
would give you an idea of your ability to pay
your debts. You would know how much of
your income is dedicated to debt, expressed
as a percentage.
"Debt servicing ratio, by its very definition,
is the ratio of your debts to your income," said
Winston Williams, financial adviser and Pan
American Life agency head, "It is a measure
of your ability to service the debt that you
"That ratio is your fixed monthly debt
expenses over your gross income," said Clifford
Manchoon, founder of the Increasing Wealth
In the past weeks, both men have assisted
Sunday BG readers with learning how to cal-
culate their net worth as well as their monthly
cash flow. This week they talk about debt
As in previous articles, Manchoon, has pro-
vided a worked example of how to go about
figuring out your debt servicing ratio. (See
"You have the total gross income or A, then
you have your fixed monthly expenses on debt
payments or B. These are your mortgage, your
vehicle, hire purchase, credit union, credit card
minimum payment and other loans. When
you go down to the bottom of the column,
you will see that your debt service ratio is B
over A multiplied by 100," explained Man-
Manchoon said most financial advisers try
to keep their clients around 25 per cent,
although most banks will issue loans to people
with debt servicing ratios of up to 40 per cent.
Williams, however, preferred the number
go no higher than 35 per cent and said even
this was at the high end of the scale.
"If you have a debt servicing ratio that is
higher than that, it means that you have
stretched yourself too thin. If you have
stretched yourself too thin, it means that any
bill outside the norm becomes catastrophic,"
Both advisers agree that the key reason any-
one applying for a loan should know their
debt servicing ratio before they go into the
institution is to save time. Persons with a debt
service ratio between 35 and 40 per cent are
likely to be turned down, they say, and the
time spent gathering records to approach
financial institutions and the actual appoint-
ment itself is wasted.
"If you are going to get a loan for a mortgage
or a car, you need to look at your total income
and look at your total debt servicing. If that
percentage is outside that rate, then don't even
bother going to the bank for them to turn you
down," said Williams.
However, knowing your debt service ratio
before going to banks is useful as it presents
an opportunity to lower the number.
Improving debt service ratio
The couple in the example provided has a
debt service ratio of 43.08 per cent.
To get their debt service ratio down to a
more acceptable percentage, a financial insti-
tution may suggest debt consolidation.
"You lump all the loans into one. You get
a longer time to pay it off and the installment
is less. This brings down your debt servicing
ratio," said Manchoon.
But this is not without its drawbacks,
because even though this one monthly loan
payment is likely to bring the debt servicing
ratio back within the 35 per cent range it
doesn't reduce the debt amount, it only
spreads it over a longer period of time.
Williams said this is why, as far as possible,
loans should be restricted to big ticket items,
such as a home or car.
He also suggested a preference for cash
over credit. The Pan American agency head
said there was a tendency for people whose
debt service ratio was already too high to
worsen the situation by using their credit
cards to meet monthly commitments.
"It is harder to use cash to pay for things
than it is to pay for a credit card. If I use cash,
I would tend to be more conservative in my
spending than if I can pull out a credit card."
Additionally, people taking advantage of a
debt consolidation sometimes neglect to ask
for key information, said Williams.
"Always ask the bank for two figures, one
is the loan pay off amount and the other is
the balance on the loan. Most people don't
understand the difference between the two.
Therefore, consolidation always seems to be
a viable option. If you find, however, that the
balance on the loan and the loan pay off
amount are the same, it means that all you
have paid is interest. Whereas, if the loan pay
off amount and the balance are significantly
different, consolidation may make sense."
Another step to reduce debt servicing ratio
said Manchoon, was to reduce expenses over
time or find a way to increase gross monthly
"If you are working at a job with a fixed
salary, you can't increase your income as you
would like. You would have to look for another
job or start a sideline business, to generate
more income," said Manchoon.
Here, a monthly cash flow statement
becomes important for pinpointing what
expenses can be reduced or cut completely.
"Try to stick within your monthly cash
flow as much as possible and to keep your
debt servicing ratio below that 35 per cent
mark," said Williams, "That is the key to
As a measure of how badly people may be
managing their debt situation, Williams said:
"People are going into the bank to extract
equity (from their home) for debt consolida-
tion. So when they were hoping to pay off
their debt by the time of retirement, their
mortgage now extends beyond retirement
because of home equity loans. That is not a
Manchoon also advised potential loan appli-
cants against "massaging facts" to make their
chances of being successful better. He said
while a denied application did not hurt them
in the long run---particularly if they reduced
their debt service ratio before reapplying---
deliberately giving the wrong information
would hurt their chances given the prevalence
of credit and other checks.
"Once the bank realises you are not being
honest with them, they will red flag you,"
He concluded that knowing your debt serv-
icing ratio puts a powerful tool in your hand.
"You could be in charge. You are not
depending on anybody to write it up for you.
You know what to do and you can put things
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt MAY 10 • 2015
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