I’m good at making money, even better at spending it.
Debt to income (DTI) ratio confuses a lot of people. Unfortunately, these people are often the ones in need of some kind of financial assistance. Many consumers aren’t aware of the simple calculation they can do to find their DTI, or the affect it has on their buying power.
As consumers, we’re generally taught about the factors that directly effect our credit score. Often consumers can feel reduced to a number because of the importance placed on this score. It’s important to know that other factors play a role in your approval chances. One of the most important is debt to income ratio.
If you’re good at making money and even better at spending it, it’s likely your debt to income ratio is too high. We tend to view credit cards as extensions of our income. While they do come in handy when the paycheck doesn’t last through the week, we forget how costly they are to use. In addition to their cost, credit card balances increase your debt to income ratio. Once your debt has surpassed 50% of your income, you’re in the danger zone.
What is Debt to Income Ratio?
The debt to income ratio is the total of your monthly debt payments divided by your total gross monthly income. Your DTI is not among the credit score factors that are used to calculate the score, but it is still viewed by lenders as an important metric for your financial stability.
If you want to calculate your DTI ratio, it’s pretty simple. Let’s say that you pay $1000 a month to a mortgage payment, $200 to an auto loan and $300 to other debts. So your total monthly payments are; $1000+$200+$300 = $1500.
Now if your income is $5000 a month, you will divide the total monthly debt by it; $1500/$5000 = 0.3 which you will multiply by 100 to get a percentage so 0.3 x 100 = 30% debt to income ratio.
How Your Debt to Income Ratio Affects Credit Score?
Now that’s a question not many people know the answer to. Many consumers don’t even know how a credit score is calculated in the first place. You need to keep in mind that there are five different factors that account for an individual’s credit score and debt to income ratio is not one of them.
You may ask, why do I even need a good DTI ratio? Well, it is another thing that the lenders use in determining whether to give you a loan or not.
If it’s not part of my credit score, why does it matter?
Put yourself in the lenders shoes. The applicant has an average credit score, with a few delinquencies on their report. However, their income is good and current debt is low, resulting in a 11% DTI ratio. The lender may be more inclined to approve this loan simply because the ability to repay is well within the consumer’s current means. A good debt to income ratio is usually under 36% that can help you qualify for a loan or mortgage.
This is because the higher your DTI ratio is, the more you are paying towards bills each month. In a lender’s eyes, taking on more debts would result in an inability to repay. This is a risk for them, and lender’s of unsecured credit prefer to limit their risk when possible.
So in short, the debt to income ratio is not among the credit score factors. But, it can affect your ability to get new credit or financing.
Over to You:
To make sure that you can leverage your credit, whatever it’s state, you need to decrease your DTI ratio. When you do this, you increase your chances of lenders approving you. Make sure to spend less, save more and pay your debts quickly to decrease your DTI and keep it under 36%.