- 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.
- Mortgage lenders are typically the strictest, requiring a debt-to-income ratio of 43% or less.
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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 – mortgage lenders, especially – 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.
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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 buy a home for the first time. Her gross monthly income is $US5,000 and her monthly debt payments include a $US300 car loan, $US100 minimum credit-card payments, and $US400 student loan payments. Amelia’s debt-to-income ratio would be 16% ($US800 / $US5,000 = 0.16). With such a low debt-to-income ratio, she’d likely be favourable to mortgage 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 behaviour to evaluate the likelihood of on-time payments.
Mortgage lenders typically have the strictest debt-to-income ratio requirements. Generally, 43% is the highest ratio a borrower can have and still get a qualified mortgage. Some mortgage lenders, both large and small, can still approve a borrower who has a debt-to-income ratio above 43%, according to the Consumer Financial Protection Bureau, but they would have to make a “reasonable, good-faith effort” to determine repayment ability.
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