Featured feature: debt ratios

Debt ratios are important. And the cost-of-living crisis makes affordability assessments are more important than ever.

To help loans officers identify problems early on, the NestEgg decision engine displays three debt ratios, speeding up loan decision time because we do the calculations, so you don’t have to.

Credit worthiness rules from the FCA state that affordability means a borrower can afford all credit commitments and bills, not just your loan.

Monthly spend

Some loan applicants are already spending a lot of their monthly income servicing credit commitments. An increased spend on gas or electricity could tip some people over the edge.

Because of this, the first ratio displayed is a monthly debt ratio.

This relates to the ratio of monthly payments to monthly income. For example, Alice earns £1,500 each month, spending £600 on repaying credit. This is a ratio of 40% (£600 / £1,500). That’s probably too high. It may only take one or two larger heating bills over winter to make it really hard for Alice to keep up her payments.

Total commitments

If someone is struggling to pay their bills, their overall debt burden will increase. This is because gas, electricity and water bills are all considered credit accounts and are reported to the credit bureaux. Therefore, these accounts contribute towards the total amount owed.

To assess indebtedness, a second ratio displayed: the annual debt ratio.

This relates to the ratio of total debts to annual income. For example, Bob has £10k in loans and has an annual income of £30k. This is a ratio of 30% (£10k / £30k). That’s pretty low. But if Bob owed £30k, that may be an issue. If this was rising, it could be a reason for a decline.  

Use of credit cards and overdrafts

Credit card balances that creep up, can be a sign that the applicant is using credit to meet day to day living expenses. If gas and electricity are paid for by direct debit or cash, cashflow might be too tight. Consequently, the food bill may end up on a credit card.

To assess these risks, NestEgg decision engine displays the balance to limit ratio.

This relates to the proportion of credit card and overdraft limits that have been utilised.  For example, Alice has a credit card balance of £9,000; 2 cards with limits of £10,000.  This is a ratio of 90% (£9,000 / £10,000). That’s high and a possible sign of financial vulnerability. Additionally, if this has increased from 50% over the last few months, that’s another warning sign.

Debt ratios are one of many features offered by NestEgg’s decision engine. And the feature list keeps growing. New functionality added all the time at no extra cost to our users.

About Adrian Davies

Adrian is a co-founder at NestEgg. He is an alternative finance and credit union expert with extensive experience of start-ups, business development, IT, Target Operating Models and regulatory compliance. Adrian has 20 years’ experience in the responsible lending sector, supporting credit unions with innovative ideas so they can grow and meet service user needs.