This is a guest post from Debt Lead, who has a debt consolidation website by Kimberly Credit Counseling.
What is your debt to income ratio? If the percentage is greater than 36%, your credit score will be negatively affected because you are considered to have too much debt. This means credit card companies and banks will likely turn down your application. Each lender sets its own policy and while some might accept you, many others will only approve your loan if you have a ratio below 30%. The general rule of thumb is to keep your debt to income ratio below 36% if you ever want to get financing.
To calculate your score, you need to add up your monthly fixed expenses. These expenses include all debt such as: house payment or leases, credit card other revolving credit balances, car payments, alimony, child support, etc. Do not include grocery, telephone, and utility bills or any debt that will be paid off in the next few months. If your car loan will be paid off two or three months from now, don’t include it in the equation.
Here is a sample calculation:
Gross monthly household income: $5,000
Fixed expenses: $1,600
Debt-to-income ratio calculation:
$1600/$5000 = 32%
The above shows that this person’s debt to income ratio is 32%. I would advice him to start paying down his debt rather than accumulating more. Unfortunately, he can probably still get approved for another credit card provided he has a good record of paying his bills on time so it’s important to be careful and not keep accumulating debt!
What is your debt to income ratio? Do a quick calculation and see!
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{ 4 comments… read them below or add one }
One way to keep your debt to income ratio high is to keep your credit card accounts open once you pay them off or decide not to use them anymore. Some people make the mistake of thinking they need to close that account, but it actually reduces your credit to debt ratio. So if you have paid off a card and want to get rid of it so you’re not tempted to use it anymore, cut it up or freeze it in a chunk of ice in your freezer. That way you maintain a high credit/debt ratio but aren’t racking up extra charges.
Responding to Emily’s comment: I think this is only true to a certain degree, because at some point lenders look at your overall available credit. I’d be interested to know if rules have changed in the past several years since I was affected by this, though.
One trick I used when I was struggling to get out of almost 2x my salary in credit card debt (now down to zero!) was to cut up all cards except for the one where I had the most available credit, wrap that one in paper then in duct tape, and keep it in my wallet for dire emergencies. I wasn’t about to pull that sucker out for anything less than something like being stranded with a broken down car in the middle of nowhere!
This is counter to all the things I’ve read. Do banks LOOK at your Debt-to-Income ration? Yes, I’m sure they do. But I was lead to believe it is not a part of your credit score – debt-to-CREDIT ratio is.
http://en.wikipedia.org/wiki/Credit_check#Makeup_of_the_credit_score
Its refreshing to see something I learned at college here, and being able to understand all that is written in this post!
PS: I am a finance major in my 3rd year