If you wish to know what Debt Service Ratio means than it is something which is used for both businesses and on individual basis to calculate how conveniently a borrower will be able to oblige to the financial responsibilities of the debt. For an individual or a house the debt service ratio is the disposable monthly earnings (the net value) minus the taxes, the rent and other running expenses such as tuition and then this is divided by the compulsory loan payments every month (minimum value).
If you Calculate Debt Service Ratio and the value is higher than the borrower is at more ease to pay back the borrowed loan and the risk for being a defaulter will be lowered. This ratio value for the lenders will be influenced by many factors but ratio of 1 to 2 is acceptable. You must remember that Debt Service Ratio is a crucial aspect which is considered while assessing the loan applications. However we must look into the perks and drawbacks when one calculates Debt Service Ratio.
Advantages and Drawbacks of the Debt Service Ratio
The main advantage of the Debt Service Ratio is that it can easily be calculated and will give a speedy assessment of financial situations for both the companies and the individual borrowers. Furthermore it will also let the loan officers consider a scenario by figuring out that how the calculated ratio will influence the approved amount of the debt which is to be borrowed.
However on the other side you must know that this debt service ratio can mislead when the earnings of an individual or a company are fluctuating. Let’s consider an example of a writer who just received $20,000 as advance for a book he is writing will be eligible to get a good amount of this ratio according to his recent account figures even if they do not earn a penny for another year or a company may have just received a payment for their finalized project but in the next few months their expenses will be influenced by cash outlays or investments in new projects and hence this ratio will be misleading.