Friday, July 12, 2024

Understanding Debt-to-Income and How to Make It Work in Your Favor

Lenders use lots of factors to work out whether or not they should approve loan applications. The debt-to-income ratio is one of the most important aspects checked as part of this process.

So what is this ratio and are there any ways to use it to your advantage when applying for a commercial mortgage?


The basics

As the name suggests, the debt-to-income calculation is a simple way of working out how much money you are bringing in each month and how much your current outgoings eat into this figure.

The lower the proportion of your income that is committed to paying down your existing debts, the more likely it will be for a lender to greenlight your commercial mortgage. You could even unlock better interest rates for mortgages if a lender can see that your debt-to-income ratio is at the smaller end of the spectrum.

As you might expect, this is a calculation that takes place not only for individuals applying for mortgages but also for businesses that are looking to buy the property outright rather than just renting it.

The inclusions

Another point to mention here is that not all of your monthly outgoings are considered as part of the ratio calculations. In general, only necessary and unavoidable expenses will be included, specifically relating to the payments owed on loans you may already have.

This gives a little more wiggle room when it comes to making a commercial mortgage affordable. If there are some costs that can be trimmed to better accommodate the repayments a lender will require, your creditworthiness will increase.

The ideal scenario

At a maximum, you should aim for a debt-to-income ratio for your company of 36%. This is broadly used as a benchmark by lenders, and any organization which has a ratio above this may not be eligible for loan approval.

As mentioned, the smaller you are able to shrink this proportion, the more favorable the terms of the commercial mortgage you will eventually secure.

Of course, this is just a generalized look at debt-to-income ratios for commercial mortgage customers. Lenders may take a different view depending on the industry you occupy, the assets you have ownership of, the credit history you have built up and the relationships you have established. If so, it could be possible to get a mortgage with a ratio of over 36%.

The ways to work with your debt-to-income ratio

By now it should be obvious that every business has unique financial circumstances to encompass when applying for a mortgage, and the debt-to-income ratio is just one piece of the puzzle.

However, you can still take action if you do not fall within the aforementioned ideal parameters for this ratio.

First of all, if your industry niche allows it, you could still be eligible for a loan even with a higher-than-ideal ratio. Getting advice from a finance specialist is a good way to know whether or not this is a possibility.

Second, paying down your existing debt to improve your ratio may massively improve your chances of approval. You might not always want to use your capital in this way, especially if you are investing aggressively to secure growth, but for some firms, it could be a good strategy.

Lastly, look into the lenders themselves and find one that is experienced in providing commercial mortgages to companies in your field.

In essence, do your research and carry out your own assessments of your debt-to-income ratio so that you are able to go into the mortgage application process with your eyes open.


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