Debt factor

A debt factor is, in the classic loan context, the ratio of a debtor/borrower's debt to income.

Basically, a debt factor can also be the ratio of a customer's credit/loan to their revenue or a similar reference.

The debt factor is a management tool for a bank or lender - the higher the debt factor, the higher the risk.

In Denmark, there are recommendations that a debt factor for an owner-occupied home should not exceed 3.5. If the debt factor exceeds 3.5, the bank will often base the loan on an assessment of the household's overall financial situation.

Banks and lenders also use the debt factor to control how many loans are issued with different debt factors.

Too high debt factor

Basically, there are a number of recommendations from various authorities as well as lenders' internal rules for what a debt factor should be.

As a rule of thumb, a debt-to-income ratio below 4 is typically not a challenge for loan approval if all other financial conditions are in order.

If the debt factor exceeds a certain level, e.g. 4, the bank or lender may impose stricter requirements. For example, they may require the loan to be a "safe loan" and only allow bond loans with a fixed interest rate, installments and over a long period. Such a loan does not fluctuate and therefore poses less risk to the bank than a variable rate loan.

There may also be other factors that come into play if your debt factor is high, such as large savings, stock portfolios, or assets that can have a positive impact on the rating.

Calculate the debt factor

Calculating your debt factor is relatively simple - you calculate it by comparing your household's total annual income with the amount of debt.

An example of a calculation could look like this:

Loan: DKK 3,000,000
Income(s): DKK 700,000

3.000.000 / 700.000 = 4,3

In the example above, the debt factor is 4.3.

Why work with debt factors?

All debt carries a risk of not being paid or defaulting. Default can occur if the borrower dies or has a change in financial situation.

Therefore, the creditor/lender needs tools to ensure that excessive credit or debt is not granted to people who shouldn't get it - thus reducing its own risk.

The debt factor is just such a tool that provides a clear overview of how many borrowers are low, medium or high risk. The lender can often accept a certain number of borrowers with a high debt factor as long as there are also customers with low debt.