Debt-to-income ratio important as credit score |
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| The DTI ratio is something lenders
look at in addition to your credit score. Remember, your credit score only reflects
your payment history and does not have anything to do with your income. You can
have a very high credit score with very little income. Conversely, you can have
very high income and a very low credit score. That's why lenders use both. To
be sure you're on solid ground, McCurdy recommends trying to bring your overall
number to 30 percent or below. After all, you have plenty of other financial obligations,
from groceries and utilities to restaurants and entertainment. "You never
know when you're going to have an emergency," she says. "You don't want
to get in trouble -- and potentially lose your home or car." Cutting
your ratio
Reducing your debt-to-income ratio can be challenging,
since these financial obligations are, by definition, ongoing. But there are tactics
you can use to start addressing the problem, says McCurdy. "Look at where
your cash is going," she says. "Ask yourself where you can cut back."
| You can change your ratio by increasing income or
reducing spending and debt. | | |  |
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Find
areas to cut costs. After you've looked at your budget and done some
cost-cutting, take the money you've saved and put it into your highest-interest
loans and debts -- most likely your credit cards. Double
up on credit cards. McCurdy recommends at least doubling your minimum
payment to start chipping away at your debt-to-income ratio. If credit cards aren't
the problem, you can also pay more on any other loan, as long as there are no
prepayment penalties.
Stop charging. Once you've started making progress, make sure you don't
rack up more credit card debt, says Russell.
Build an emergency fund. Instead, build up an emergency fund so you
can replace your furnace or pay off a vacation without going back into credit
card debt.
Avoid
major purchases. If you're teetering on the edge of problems, it might
be wise to hold off on major purchases, Russell says. "Don't overextend yourself
with a new car loan or mortgage loan," she says.
Consider getting help. If you still can't rein in your ratio, you may
need to get the help of a financial adviser who can help you consolidate loans
and put you on the right track.
Another
ratio
There's also a second, related ratio that's helpful if you want
to judge whether you can afford to buy a certain house or if you
want to know you can still afford to live in your existing home.
Perhaps your income has dropped or expenses have changed significantly
because of a new, higher interest rate, new tax hike or skyrocketing
insurance costs.
This figure is called
the front-end ratio and you can calculate it by adding up the monthly principal,
interest, taxes and insurance, and divide it by your gross income. That number
generally should be no more than 28 percent, says Russell. "You might see
exceptions for a first-time home buyer or someone with marginal credit, but in
general, you don't want to go above that, she says.
Keeping your front-end and back-end ratios in check
will help you stay financially stable. If you find yourself edging
into dangerous territory, McCurdy recommends cutting back on spending
for entertainment and restaurants, paying more than the minimum
payment on your credit cards and tackling your highest-rate loans
and credit card debts first.
Even if your numbers fit within the prescribed
ratios, be sure that they make sense for you. "We're always being lured by
advertising to buy these wonderful things," says McCurdy, "but just
because you qualify for something doesn't mean you're managing your money well.
If you take everything to the limit, you don't leave much room for error." | 
