Most consumers know that they need to have a decent credit score to obtain approvals for new credit items such as credit cards, auto loans, mortgages and personal loans. A debtor’s credit score makes a huge difference in whether that person receives the best interest rates and finance charges. However, another element exists that may be just as important as a person’s credit score: debt-to-income ratio. A person who has a poor debt-to-income ratio with good credit could still receive a denial on a loan product. The debt-to-income ratio is a crucial element in consumer and creditor relations.
What Is Debt-To-Income Ratio?
Debt-to-income ratio is a two to three number figure that represents a person’s total debt in relation to his or her income. The figure is easy to calculate. A wide variety of calculation tools are available online to help a person to figure this amount. A debtor who would rather calculate the figure himself or herself may use a pen and paper to come up with the figure. The number that the debtor receives will give him or her an excellent idea of his or her standings in the credit world.
How to Calculate Debt-To-Income Ratio
To calculate debt-to-income ratio, a debtor will need to know all of his or her income sources and debts. Debt includes payments to credit card companies, auto lenders, student loan companies and the like. Income can include any source of income the person has such as funding from a full-time job, part-time job, work-from-home opportunity, unemployment compensation, disability benefits and more. To calculate debt-to-income ratio, the person needs to total the two figures and then divide his or her monthly debt by his or her monthly income.
Why Debt-To-Income Ratio Is Important
Debt-to-income ratio is important because it tells creditors whether a person can handle a new loan. The figure represents the amount of income that the debtor’s credit accounts utilize. Therefore, a person who has a 90 percent debt-to-income ratio only has 10 percent of his or her income left to pay an additional bill. Therefore, a person who earns $500 per month would only have $50 a month left to pay for a bill. This would trouble a lender because it appears as if the person cannot repay a loan. Even if the debtor has excellent credit, the debt-to-income ratio may affect a lender’s decision.
What Should a Person’s Debt-To-Income Ratio Be?
A vast majority of lenders considers a 50 percent debt-to-income ratio too high. A person who wants to appear responsible in the credit world will want to have a debt-to-income ratio that is less than 36 percent. Some lenders may approve loans for people who have DTIs under 50 percent. However, those consumers may not be privy to the best deals on the market.
How to Improve a DTI Number
A consumer can improve his or her DTI number using a variety of strategies. Paying off accounts is one way to decrease a DTI number. Disputing accounts that do not look legitimate is another way to lower the DTI. The credit bureaus must remove any accounts they cannot prove. Therefore, a debtor with a questionable DTI may want to obtain a copy of his or her credit report. All three credit bureaus are obligated to supply debtors with at least one free copy of their credit reports each year. The information contained in a person’s credit report can help him or her to lower DTI.
A service such as credit counseling may help people who have extremely high DTIs. A credit counselor can stress the importance of smart spending and teach the person not to rely on creditors for goods purchases. Once the consumer has a low enough DTI score, he or she will be eligible for a wealth of financial products.