The Importance Of Having A Good Debt To Income Ratio

There are many things that have changed in the world of personal finance in the past few years. Consumers are now paying close attention to their money and where it is spent. Banks are paying even more attention to those who apply for loans. One thing that hasn’t changed is the importance of having a good credit history. In fact, your credit history is probably more important today than it was a few years ago when lenders were more inclined to take a risk when loaning money.

Your credit history is not the only factor determining whether or not you will qualify for credit. If you are applying for a loan, your debt to income (DTI) ratio will most likely be the first number your lender looks at to determine your credit risk. Your debt to income ratio represents how much of your current income is currently used to repay your debts. Generally speaking your credit history/score shows a lender how you have managed your financial obligations in the past, while your debt to income ratio indicates whether or not you can afford to repay a new loan. Lenders consider applicants with a high debt to income ratio a greater risk. Each lender has their own DTI limit when considering loan applications for approval.

It is important to know what your debt to income ratio is before applying for a loan. If your debt to income ratio is high the chances of being turned down for a loan increase. How do you know what lenders consider a high DTI ratio? Lenders are interested in two ratios; the first number represents what percentage of your income is needed to pay for housing expenses, such as mortgage payments or rent. The following expenses may be included for homeowners: insurance premiums, property taxes and homeowners association fees. The second number is calculated using the same income and housing expenses as the first, however other reoccurring debts are added such as credit card payments, child support and auto loans. When banks calculate your debt to income ratio they are looking for applicants who meet or fall below a predetermined limit. If your debt to income ratio is good (low) you increase your chances of getting approved for your loan at a favorable rate. Conversely a high debt to income ratio suggests to lenders that you do not make enough money to add additional debt to your financial obligations. This will either result in your loan application being denied or approval of the loan at a higher interest rate.

Debt to income ratios are a valuable tool in determining how much money a person can afford to borrow. When used as a guideline and in conjunction with other financial information it is possible to accurately predict whether a person should be approved for a loan. Unfortunately in most cases lenders do not evaluate all of your financial information thereby granting approval to consumers who really cannot afford another debt. For this reason all borrowers are encouraged to sit down and carefully review their budget to determine if adding another loan payment is something they can truly afford.