When a lender looks at your credit worthiness, your debt-to-income ratio, commonly called DTI, is just one of the numerous factors considered. Your ratio indicates to lenders whether or not you’re in financial distress and what the chances are that you will repay your loan or credit card balance in the future. In general, banks don’t use your DTI for credit card applications, but high debt does impact your credit score.
Your debt-to-income ratio is calculated by comparing your total monthly debt payments to your gross monthly income. Your monthly debt obligations can include your mortgage payment -- plus applicable interest, insurance, and escrow deposits -- your current minimum credit card payments, student loans, personal loans, and auto loans. Your utility payments and other varying monthly payments are not included in your DTI.
All you need is a calculator to total up your DTI. Add up your gross monthly income -- including your spouse if you plan on using joint credit applications. For example, you earn $5,000 each month. Next, total your monthly debt obligations, but exclude variables such as utilities, gas and groceries. For credit cards you currently have, only add the monthly minimum payment, even if you typically pay more. For example, you spend $2,000 per month on monthly debt payments. Divide your total monthly debts by your gross monthly income to arrive at your DTI expressed as a percentage. In this example, your DTI would be 40 percent, meaning that 40 percent of your gross income goes to pay debt.
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A high DTI can bar you from a new home loan, but it doesn’t impact whether or not you get a credit card. Instead, banks and other credit card issuers are more concerned with your three-digit FICO credit score. Too much debt and too high a level of credit card balances can negatively impact your credit score, making you ineligible for new credit cards. According to myFICO.com, 30 percent of your credit score is based on credit utilization -- meaning the amount of available credit in comparison to the credit card balance. If you’re late on your monthly credit card payments, your score could be even lower.
Improving Your Credit Worthiness
Ideally your maximum DTI should be 36 percent or lower, according to Bankrate. If your DTI is higher than this, working to lower your monthly debt can improve your chances for new loans in the future. Even if banks approve your DTI, too high of a DTI can reduce the amount you’re approved for, which means you might not be able to buy the home of your dreams in the future. The lower your DTI, the better interest rates and room for negotiations you have with lenders. Lower your DTI by paying off credit cards and any outstanding loans you can pay off, or by refinancing loans to reduce your monthly payments.
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