What affordability means: repaying without hardship

Two questions, not one

The United Kingdom's consumer credit rules put the distinction plainly. Before lending, a firm must assess creditworthiness, and that assessment covers two risks: the risk that the customer will not make the repayments by their due dates, which is the lender's credit risk, and the risk to the customer of not being able to make the repayments, which the rules treat as affordability. The first is about the lender's money; the second is about the borrower's situation.

The two can move apart. A borrower may keep paying on time while cutting food or school spending, falling behind on rent, or taking a new loan to pay the old one. The lender sees a good payer; the household is in difficulty, and the risk may show up later.

What 'able to repay' means

The same UK rules list what the lender must consider about the customer's ability to repay. In short:

• Repayments can be made as they fall due over the whole life of the agreement, not only at the start.
• They are made out of the customer's income, income received jointly with, or by, another person, where it is reasonable to expect it to be available to the customer, or savings or assets the customer has clearly said will be used.
• The customer does not have to borrow to meet them.
• The customer does not fail to make other payments that are contractual or statutory obligations.
• The repayments do not have a significant adverse impact on the customer's financial situation.

In the United States, Regulation Z requires a mortgage lender to make a reasonable and good-faith determination that the consumer can repay, and lists the factors it must consider, among them income or assets, employment status, the payment on the new loan, current debt obligations, the debt-to-income ratio or residual income, and credit history. The wording differs between markets; the idea is the same.

Why a good score or good collateral is not enough

A credit score ranks applicants by how likely they are to fail to repay (credit scoring course, lesson 1). It says little about how much of the household's budget a new instalment will take. Collateral protects the lender's recovery, not the borrower's budget. The Financial Stability Board's principles for mortgage underwriting say that the loan-to-value ratio should not be relied upon as an alternative to assessing repayment capacity, and that lenders should take into account the borrower's other debts and make reasonable allowances for committed and other non-discretionary spending.

Two ways to measure it

Affordability can be looked at in two ways. The first is a ratio: how much of income goes to debt repayments. The second is what is left: the money that remains after repayments and, in many approaches, after essential spending. Regulation Z defines both for mortgages: the monthly debt-to-income ratio is total monthly debt obligations divided by total monthly income, and monthly residual income is what remains after subtracting the debt obligations from the income. Lesson 3 and lesson 4 look at each in detail.

Debt-service ratio = all monthly debt repayments ÷ monthly income; Amount left = monthly income − essential spending − all monthly debt repayments

Worked example, with illustrative numbers. A borrower has a monthly income of 20,000, essential spending of 12,000 and existing repayments of 3,000, and applies for a loan with an instalment of 4,000. The debt-service ratio would be 7,000 divided by 20,000, or 35 per cent, which may look moderate. But only 1,000 would be left each month after essential spending and repayments, a thin margin for a sick child or a month of lower earnings. The two measures can tell different stories, which is why it helps to look at both.

Why it matters to the lender too

Affordability is not only a matter of borrower protection. Bank Negara Malaysia, in a 2024 analysis, reported that under severe unemployment and income shocks in its stress test, borrowers with a debt-service ratio above 60 per cent were up to 5.5 times more likely to default than borrowers with low ratios. The same analysis found that relying on the ratio alone may be insufficient to fully explain borrowers' capacity to service debt, and combined it with the income left after loan repayments.

How deep the check goes can vary with the loan. The UK rules say the extent of the assessment must be proportionate to the individual case, taking into account factors such as the amount of credit, its duration and its cost. A small, short loan and a large, long one do not need the same depth of work, but both need the question to be asked. For what applies in each Southeast Asian market, see the rules pages.