Your Credit score isn’t the only number lenders use to decide if you’re trustworthyMay 9th, 2019
Many lenders look at debt-to-income ratio to decide whether a borrower is trustworthy.
Your debt-to-income ratio is all monthly debt payments divided by gross monthly income.
In addition to a person’s credit score, debt-to-income ratio is used by lenders to evaluate whether a borrower can afford to take on another monthly payment. A ratio of 35% or less is generally good
Your credit score isn’t the only thing that could make or break your ability to get a loan or line of credit.
Many lenders will also calculate a potential borrower’s debt-to-income ratio to determine whether they’re suited to take on another monthly payment.
You can find your debt-to-income ratio through a simple calculation: Divide all monthly debt payments by gross monthly income and you have a ratio, or percentage (once you move the decimal point two places to the right).
A debt-to-income ratio of 36% or less is generally good for homeowners, while 15% to 20% is good for renters, according to the Consumer Financial Protection Bureau. The lower the percentage, the better you look to lenders, because it indicates your debts make up a smaller portion of your earnings.
Payments for auto loans, student loans, mortgages, personal loans, child support and alimony, and credit cards are all considered monthly debt. Notably, the calculation uses the minimum credit-card payment combined across all credit cards, rather than the amount you actually pay each month. Household utility bills, health insurance, and car insurance costs aren’t considered debt.
For example, let’s say Amelia wants to Lease a car for the first time. Her gross monthly income is $5,000 and her monthly debt payments include a $100 minimum credit-card payments, and $400 student loan payments. Amelia’s debt-to-income ratio would be 33% ($500 / $5,000 = 0.33). With such a low debt-to-income ratio, she’d likely be favorable to car lenders.
While debt-to-income ratio isn’t connected to your credit score (and thus, doesn’t affect your credit report), the two have a fairly symbiotic relationship.
The two most important factors the credit-scoring agencies use to determine a credit score are payment history and current debt balances — they make up 65% of your credit score. While credit-scoring agencies don’t have access to a person’s income, they’re still able to consider past behavior to evaluate the likelihood of on-time payments.