Having a good FICO score and positive results on your credit report is essential in maintaining good credit. While these two things are the primary determining factor in lenders deciding whether or not to lend you credit, your debt to income ratio also plays an important role. Understanding how your debt to income ratio works and how it can affect your credit will help you keep your credit status favorable for borrowing.
Debt to Income Ratio
Your debt to income ratio is a percentage that is based off of the amount of income that you receive each month and the amount of debt that you owe each month. To calculate your debt to income ratio, you need to tally all of your monthly debt, such as your mortgage, car payment, student loan payments, revolving loan accounts and credit card payments. Add up the total and divide this amount via your monthly gross income--this will give you a percentage. This percentage is your debt to income ratio. Most lenders look for borrowers who have a debt to income ratio below 36 percent. Anything higher than this is considered high risk and could prevent you from obtaining a loan.
Using Debt To Income Ratio Figures
Your debt to income ratio is used when you are applying for a long-term loan, such as a mortgage or vehicle. Because your debt to income ratio is not visible on your credit report or FICO score, the information must be gathered from your loan application, pay stubs and W-2s. Many times a lender will request this information and also ask for additional proof of income to see if your score can be adjusted before making a lending decision.
Who Uses the Information
Understanding your debt to income ratio before applying for any type of loan from a bank will help you be more prepared for the application process. When applying for a credit card most banks will not consider the debt to income ratio as much as they will base their approval off of your FICO score alone. Mortgage lenders and banks who loan money for automobiles, may want to dig deeper into your credit lifestyle. They can do this by evaluating your debt to income.
Lower the Ratio
While a debt to income ratio above 36 percent can affect your credit and prevent you from getting a good interest rate, there are ways to lower the number so you can maximize your credit power. You can start off by eliminating as much monthly debt as possible. Focus on making double payments on your largest loans and paying off your smaller loans so there is a zero balance remaining.
Considerations
Some people think that by adding another borrower to a credit application that they will be able to increase their chances of getting a loan. If the borrower's income is higher but they still carry a large debt load it could actually increase your debt to income ratio. This can affect your credit by lowering the probability of receiving a loan offer. Another thing to consider when determining debt to income ratio is that monthly household expenses such as utilities, food and other miscellaneous expenses are not calculated.
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