Financial burden

economic-dictionary

The financial burden is the sum of the different financial expenses and the amortization of the capital, referred to the loans formalized and pending repayment.

In other words, we refer to the amount that an individual or legal entity has to face to return the principal and interest on the loans.

The financial burden, from another perspective, is the percentage of current income that we must allocate to the payment of financial expenses, whether of an individual or a company.

A concept directly related to the financial burden is the fee imposed by a lender to use their money. In addition, this fee allows said lender to obtain a certain yield, previously agreed upon before formalizing said loan. This, for lending your money to outsiders.

This fee is made up of, in addition to the cost of repaying the debt itself, taxes, commissions, interest, as well as interest accrued from claims for non-payment.

How is the financial burden generated?

As we said, any situation that generates a subsequent indebtedness is a financial burden. Related to this, we have prepared a list of examples of products, as well as banking services, which count towards our financial burden.

Thus, the following debt instruments generate a burden:

  • Consumer loans.
  • Mortgage credit.
  • Credit cards.
  • Credit lines.
  • Automotive loans.
  • Bank loans.
  • Credits with State guarantees (CAE).

As we mentioned at the beginning, any debt situation is a burden for our domestic economy, as well as for a company if it were a loan for it. The relationship mentioned in the article could be extended with any existing debt instrument.

How is the financial burden calculated?

The calculation of the financial burden is very important. Many credit institutions use this indicator to evaluate credit operations with their clients. Depending on the load we have, the bank will make one decision or another.

For this reason, to calculate it we must do the following process:

In the first place, we must perform a computation of the formalized debt ratio that we must face. As we want to know the financial burden based on our ability to pay, we must add the debts, based on the monthly payment that we must face. For instance:

  • Mortgage loan / month: $ 600.
  • Credit card / month: $ 1,200 dollars.
  • Car loan / month: $ 200 dollars.
  • Total debt / month: $ 2,000.

Once we have calculated our monthly debt, we must calculate our liquid income, that is, the income that is produced on a regular basis. To do this, we deduct taxes. For instance:

  • Salary company / month: 3,500 $ dollars.
  • Income income from inherited housing: $ 1,800 dollars.
  • Total net income after taxes / month: $ 5,300.

Once we have calculated the calculation of income that we receive per month, on a regular basis, we must proceed to the next step. This is the final step, so we have to be very precise. To do this, we must divide the total of the monthly debt computation that we have obtained in the first step, by the total computation of income that we have computed in the second step.

In this way we will obtain a result that, when multiplied by 100, will give us the percentage of financial burden that we have.

Formula: Financial burden = (Total monthly debt / Total monthly income) x 100

For instance:

  • Total debt / month: 2,000 $ dollars.
  • Total net income after taxes / month: $ 5,300.

Financial burden: (2,000 / 5,300) x 100 = 37.73%

For the proposed example, our load is 37.73%.

How is the financial burden interpreted?

When we calculate our financial burden, as we have done in our previous example, the data we obtain is a relative figure that tells us little about the situation. However, to obtain more information, we must know how to interpret this data that we obtain, with the range of references that banks have to calculate if our financial burden is high or, on the contrary, is low.

Along these lines, many banks interpret that an excessive level of financial burden is anyone that exceeds 50%. However, this depends a lot on the entity that must study the loan. There are situations in which a good credit history causes a relaxation in the percentage. While, on the other hand, there are situations in which we talk about a new client, and the financial burden is not allowed to exceed 40%. As we say, it depends on the bank.

However, at Economipedia we consider that an optimal load should not exceed 35%. In this way we guarantee living comfortably with the income received, without putting our ability to pay at risk.

The financial burden index

The financial burden index is a widely used indicator that tries to reflect the level of financial burden that citizens of the country have, based on the obligations of the State itself. In other words, an indicator that shows the financial burden that the inhabitants of a country have, as a consequence of the indebtedness that the Government has.

To calculate it, just carry out the following formula:

Thus, we will obtain the financial burden of the inhabitants of a country, allowing it to be analyzed and compared with other nations. Measuring, as an objective of this, the level of public indebtedness that ends up having an impact on citizens.

Tags:  banking markets derivatives 

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