Your Guide to How Your Debt-to-Income Ratio Affects Your Credit Score?
When borrowing a loan, lenders must check your ability to repay by looking at your credit report. The main thing they use to determine your capability is the debt-to-income ratio. This is the amount of money you get and spend every month. That means your debt-to-income ratio has a significant impact on your credit score. The following is a short guide to the debt-to-income ratio and how it affects your credit score.
What is Debt-to-Income Ratio?
Simply put, your debt-to-income ratio is the amount you get when you divide your monthly spending with your income. This is the number that lenders use to determine if you can manage the monthly payments when you borrow from them. It compares how much you spend and the incoming amount every month. Therefore, your debt-to-income ratio can determine the interest rate the lender sets for the loan they give you.
How Do You Calculate Your Debt-to-Income Ratio?
Calculating your debt-to-income ratio requires a bit of math:
- Add your monthly expenses, including incurring debts and bills.
- Add your total monthly income. The next thing you do is to divide your total debt and bills by the monthly income.
- Multiply the amount you get by 100 to get the debt to income ratio as a percentage.
The final amount you get is your debt-to-income ratio, which lenders use to determine your ability to make monthly payments.
How Does Your Debt-to-Income Ratio Impact Your Credit Score?
The debt-to-income ratio does not impact your credit score unless you fail to pay a debt or bill. Once you don’t make a repayment, the information appears on your credit report. You should know that the credit report does not have your income details. Therefore, having a high debt-to-income ratio does not impact your credit score.
What is Considered a Good Debt-to-Income Ratio?
Many lenders want your debt-to-income ratio below 43%, while others prefer it below 30%. In short, the lower this amount, the better your chance of getting a good loan. A poor credit score could be because your ratio is high. Therefore, improve your credit score before applying for a mortgage. You can also speak to your financial advisor to help you improve your credit score.
Debt-to-Income Ratio and Mortgage Application
Your debt-to-income ratio affects your mortgage application. Lenders use the ratio to decide if they should give you a mortgage. Therefore, the lender may request details of your monthly income, debts, and bills during the application process. They use this information to evaluate whether you can repay the mortgage, debts, and bills. Therefore, in case your application is rejected, it could mean your ratio is too high. It means the lender does not think you can manage the monthly payments based on your income and how much you have to pay for everything.
Key Takeaways
From the details above, it is clear that your debt-to-income ratio impacts your loan eligibility. Your lender will need it to determine if you can repay the loan. However, your bad credit score has nothing to do with the debt-to-income ratio. They are two independent aspects, even though both contribute to your eligibility when applying for a mortgage.
