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Debt-to-Income Ratio
/ Categories: Financial Education

Debt-to-Income Ratio

In borrowing money nothing is more important than the ability to repay.  The ability to repay is even more important than your credit score.  Banks use many methods and principals to make loan decisions, your debt-to-income ratio is one of them.  Your debt-to-income ratio determines your ability to repay loans based on your current and future financial situation.

Your debt-to-income ratio is what you pay in payments each month to creditors divided by your monthly income.  For instance, if you make $1,750 per month and you have $600 in monthly payments (i.e. mortgage or rent, car loans, student loans, credit cards, etc) then your debt-to-income percentage is 34% (600/1750=.3429).  The other 66% is used for utilities, entertainment, food, gas, etc. this 66% is also known as disposable income.

In banking the highest debt-to-income ratio that is desirable is 40%.  Anything higher than 40% debt-to-income makes a customer more risky than other customers.  In our example from above, the maximum amount of debt that is appropriate each month is $700 (700/1750=.4000).  Most financial institutions use 40% as the threshold because they understand the importance of having money available to use for parts of life other than debt.  Years and years of lending and banking standards have led to the use of this threshold.

Next time you are considering borrowing money, do not only consider your credit score but also consider your debt-to-income ratio.  Having and understanding this information will help you make a more informed decision on borrowing money. 

Always remember the ability to repay your debts is the most important, regardless of credit score.  Even individuals with great credit scores are limited on what they can borrow based on their income.

Contact one of our lenders to discuss this topic or how you might qualify for a loan.

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