Find out at Equifax what the distinctions are between a debt-to-income ratio and a debt-to-credit ratio, as well as how each impacts your credit. [Duration – 2:14].
The terms “debt-to-income ratio” and “debt-to-credit ratio” may be familiar to you when discussing credit scores, credit histories, and credit reports. ” But what do these terms mean, and more importantly, how are they different?.
Ever heard the saying, “It’s not how much you make, it’s how much you keep?” Well, when it comes to getting a mortgage, that saying couldn’t be more accurate. While your credit score is definitely important, your debt-to-income ratio (DTI) might actually be the key to unlocking your dream home.
What is DTI?
Think of your DTI as a financial fitness test. It calculates the percentage of your monthly income that is used to pay off debt, such as credit card bills, mortgages, auto loans, and student loans. This ratio is used by lenders to evaluate your capacity to pay off additional debt, such as a mortgage.
Why is DTI so important?
Imagine you’re a lender. Would you rather loan money to someone who spends most of their income on debt, or someone who has plenty of room in their budget for another monthly payment? That’s exactly why lenders pay close attention to your DTI. A lower DTI indicates a lower risk for them making you a more attractive borrower.
What’s a good DTI?
Most lenders prefer a DTI of 43% or lower. This indicates that your monthly debt payments should not exceed 2043 percent of your gross monthly income. However, based on your credit score and other variables, some lenders might be more accommodating.
How can I improve my DTI?
Don’t worry if your DTI is a little high; there are ways to make it lower:
- Pay down debt: This is the most effective way to lower your DTI. Focus on paying off high-interest debt first, like credit cards.
- Increase your income: This might not always be an option, but if you can find ways to boost your income, it will automatically lower your DTI.
- Reduce your expenses: Cutting back on unnecessary expenses can free up some cash to put towards debt payments.
DTI vs. Credit Score: What’s the difference?
While both DTI and credit score are important for mortgage approval, they measure different things. Your credit score reflects your creditworthiness, while your DTI reflects your ability to manage debt. Think of it this way: your credit score is your past financial behavior, and your DTI is your present and future financial capability.
The Bottom Line
Don’t underestimate the power of your DTI. It’s a crucial factor that can make or break your mortgage application. By understanding your DTI and taking steps to improve it, you can increase your chances of getting approved for the loan you need to buy your dream home.
Bonus Tip:
Want to know your DTI? It’s easy to calculate! Simply add up all your monthly debt payments and divide that number by your gross monthly income. For example, if your monthly debt payments are $2,000 and your gross monthly income is $5,000, your DTI would be 40%.
Remember, a lower DTI is better, so start working on improving yours today!
What is your debt-to-credit ratio?
Your credit utilization rate, sometimes referred to as your debt-to-credit rate or debt-to-credit ratio, is calculated by dividing the amount of revolving credit you currently use by the total amount of credit that is available to you.
Revolving credit accounts include things like credit cards and lines of credit. They don’t need a set amount from you every month, and you can keep using the credit as you reduce the balance. Conversely, installment loans have a set monthly payment, similar to a mortgage or auto loan. When installment loans are paid, the account is closed. Installment loans generally are not included in your debt-to-credit ratio.
Why does your DTI ratio matter?
When deciding whether to lend you more money and at what interest rate, lenders may take your DTI ratio into account. Generally speaking, the lower a DTI ratio you have, the less risky you appear to lenders. The preferred maximum DTI ratio varies. However, the maximum DTI ratio a borrower can have and still be approved for a mortgage is 43% for the majority of lenders.
The Debt To Income Ratio & Why It’s More Important Than Your Fico Score!
FAQ
What’s more important credit score or debt-to-income ratio?
Does lowering your debt-to-income ratio raise your credit score?
Does income or credit score matter more?
What is a healthy debt-to-income ratio?
Does debt-to-income ratio affect credit score?
The ratio itself is not used to calculate your credit score. But factors that contribute to your ratio can also affect your credit. High credit card balances, for example, could hurt both your debt-to-income ratio and your credit score. Likewise, low balances could help both. What’s the difference between debt-to-limit and debt-to-income ratios?
Does a high debt-to-credit ratio affect your credit score?
The weight these models place on your credit utilization rate is considerable; it accounts for roughly 30% of your FICO ® Score. A debt-to-credit ratio above 30% may have a more negative impact on your credit score, as it indicates you may have a high level of debt and might struggle to pay back a loan.
How does debt affect your credit score?
Credit utilization ratios are important factors in determining many credit scores. Other ways your debt can affect your credit scores include: When you apply for a mortgage, lenders will look at DTI, your credit history and your current credit scores. Why?
What is the difference between a debt-to-income ratio and credit ratio?
The difference between your debt-to-income and debt-to-credit ratios is that DTI compares your monthly debt payments to your income, while your debt-to-credit ratio compares your monthly debt payments to your total available credit. What Is a Debt-to-Income Ratio (DTI)?