What most of us don’t realize is that the amount of debt we hold also affects our credit score. Not only is too much debt hard to keep up with, but it can lower your credit score as well. This, in turn, has a direct impact on your ability to borrow money through a loan or a credit card.
So, let’s start with getting to know some basic debt related questions and their answers.
What is too much debt?
Too much debt is not a number. It does not mean having a loan of ₹10 lac or having ₹50,000 due on your credit card. Too much debt is a situation where your debt is not in proportion to your income. There is no way to put a definite number on “too much debt”. This is calculated based on DBR.
What is DBR and how is it calculated?
DBR is Debt Burden Ratio. To say in simple terms, it is the amount of burden that your debt puts on your income. It is generally expressed in the form of percentage, such as 25% debt burden ratio, or 30% debt burden ratio.
Let us take an example. Say your income is ₹50,000, and currently have the following debts:
Car Loan EMI= ₹15000
Personal Loan EMI= ₹2000
Credit card dues (monthly average)= ₹5000
So, your total monthly debt burden is ₹25,000.
And your DBR = (25000/50000)*100 = 50%
In such a situation, where your debt burden is 50% or more of your income, it would become difficult for you to keep up with your EMIs. This would be called a situation of too much debt. Thus, if for any reasons your debt gets to a point where your monthly dues are more than 50% of your income, then your debt would be considered too high.
How does DBR affect your credit score?
A bad DBR means you have too much debt burden. This can affect your credit score severely because it increases the chances of missed payment. You already have too many monthly dues and that leaves too little room for unplanned expenses that arise every now and then.
In simple words- too much debt makes you look like a risky borrower to the financial institutions. And that can lead to a drop in your credit score.
What can you do to keep your DBR in check?
Keeping your DBR in check means keeping the amount of your debt in check. There is no sure shot rule to keep your DBR in check. However, the following steps will help you:
- Pay your bills on time, each month: Don’t let your bills pile up. Mark all your important monthly payments in a calendar, be it your EMI payment, or your regular utility bills. And ensure that you don’t miss paying any of them.
- Pay more when you can: Whenever you have any extra cash on your hands, use it to pay off your existing loan or credit card debt. Be it your bonus, or extra savings in a month, make sure you don’t just let that money sit around.
- Pay off the costly debt first: Some debt is costlier than the other. Here’s an example: your credit card debt is probably costlier than your personal loans because it comes at a higher interest rate. So, always pay off the costlier debt first.
