Debt-to-income ratio important as credit score
|By Erin Peterson
By now you know your three-digit credit score is a
very important number in your financial life, but did you know there's
also a two-digit number that can be just as significant?
It's your debt-to-income ratio, and it can shed a
light on, and help you better understand, your true financial picture.
The good news is, getting this number doesn't cost
you a penny, and it can be calculated in just a few minutes at your
So, if you think
getting insight into your financial life requires sifting through your retirement
investments, reading through every fund prospectus and tallying your expenses
to the penny, think again.
It's true that nitty-gritty details
can make a difference, but you can get a fairly accurate understanding of your
financial picture by spending just a minute or two calculating your debt-to-income
ratio. By knowing the ratio -- and how to improve it -- you can increase your
chances of getting a better mortgage, a better car loan and even better credit
Your debt-to-income ratio is exactly what it sounds like: the amount
of debt you have in the form of mortgages, car loans, student loans
and credit card debt, as compared to your overall income.
To calculate your overall debt-to-income ratio, sometimes
known as a back-end ratio, add up all of your monthly debt obligations
-- often called recurring debt -- including your mortgage (principal,
interest, taxes, and insurance) and home equity loan payments, car
loans, student loans, your minimum monthly payments on any credit
card debt, and any other loans that you might have. Do not include
expenses such as groceries, utilities and gas. Take this total and
divide it by your gross monthly income from all sources. If you're
not good at long division or don't have a calculator handy, go to
calculator section to use our debt-to-income
Some lenders will exclude the mortgage payment from this equation, but they lower
the ratio. The concept is the same: it measures your debt load in comparison to
Let's say you and your spouse together earn $83,000
per year or $6,916 per month. Your total mortgage payment is $1,350,
your car loans total $365, your minimum credit card payments are
$250 and your student loans add up to $300. That equals a recurring
debt of $2,265 a month. Divide the $2,265 by $6,916 and you'll find
your DTI is 32.75 percent.
In general, you'll want to keep that
number below 36 percent -- a threshold that loan officers and credit card issuers
often use as a factor when they determine how much they're willing to lend you.
"If you go higher than 36 percent, you are on a slippery slope," says
Diane McCurdy, a Certified Financial Planner and author of "How
Much Is Enough?" Lenders might give you money, she adds, "but they'll
give you higher interest rates, and if anything goes awry, they'll sock it to
So why is that number so important? It's all about
proportion, says Laura Russell, a certified financial counselor with GreenPath
Debt Solutions. "You can be making a lot of money every month, but if
you've got the debt to match it, that can be a problem," she says. "It's
important not to overextend yourself." The higher your number, the riskier
it is for lenders to offer you loans -- and the more they'll make you pay for
debt-to-income ratios don't have the kind of buzz that credit scores do, they
can play a key role in determining if you qualify for a loan and how much you
can get. "Your debt-to-income ratio is one of the tools that banks will use
to determine whether they'll lend you money for a mortgage, a car loan or a student
loan," says Dave Hinnenkamp, CEO of KDV
While other factors, such as your credit
score and length of time in your home or job, will come into play into this equation,
a good debt-to-income ratio can give you leverage to negotiate if other factors
aren't in your favor. "The stronger you are financially, the more leverage
you have when negotiating interest rates or loan amounts," says Hinnenkamp.
"So there is an advantage to keeping that ratio low."