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Debt To Income Ratio And Not Income Determines Your Credit Score

by Michael Redbourn
Surprising as it might seem on first hearing, your credit score is simply based on a debt to income ratio, and how big or small your income is, is only relative to your outgoings. It’s Quality And Not Quantity.

Your credit score merely attempts to predict your ability to make payments based on your past payment history and your current level of debt, and no attempt is made to predict how much debt you’re able to take on based on your present income.(continued below)

Debt To Income Ratio And Not Income Determines Your Credit Score

Two Different Metrics.
Lenders use different metrics to understand how likely it is that a would be borrower will be able to repay a loan, and the two most commonly used ones are Front-end and Back-end Debt-to-Income (DTI) ratios.

The names are a mouthful, but they simply describe ratios that are used to compare your fixed outgoings to your monthly income, and they don’t do a lot more than give the lender a sense of whether you’ll be able to honor your new commitments or not.

A high DTI indicates that a large portion of your income will be eaten up by existing obligations, meaning that the higher your DTI is the less likely it is that you’ll be able to manage any new obligations.

What Is PITI!
PITI has nothing to do with feeling sorry for somebody, but is a person’s monthly housing expenses and they’re made up of principal, interest, property taxes, and insurance (PITI).

Front-End DTI.
A front-end ratio is arrived at by comparing a person’s monthly housing expenses to their gross (pre-tax) monthly income, and things such as mandatory homeowner’s association dues, and mortgage insurance are added to the PITI.

Most lenders look at a candidates annual income and expenses rather than at his or her monthly ones, and they use Front-End DTI to gauge your capacity to pay for either your proposed or current housing.

Historically lenders considered a housing figure of 28% as one after which housing would be deemed overly expensive, but this figure has gradually been raised and now stands at 30% in the U.S.

A great number of private mortgage companies stretched the number to 33 percent during the mortgage boom and the results were catastrophic.

Back-End DTI.
Back-End ratio, is essentially the comparison of a person’s total monthly debt payments, which is made up of PITI, plus ALL other monthly debt payments, to their gross monthly income.

“ALL”, means exactly what is says and it includes all traditional debt, such as credit card payments, medical debts, student loans, auto loans, child support, alimony, judgments, and any other monthly loans or obligations.

How Healthy Are You?
32 percent is fantastic and anybody with this kind of ratio is welcomed by smiling faces and open arms by lenders, the ratio is an extremely conservative debt load and poses the lender very little risk.

33-36% is also thought to be extremely manageable by lenders since the debt load would seem to present minimal risk.

37-42% would be considered OK for a short term loan but if you’re after a long term one then try to get your ratio down a little before applying.

A debt ratio of 43-49% is considered high and it indicates possible future economic problems. If you’re in this bracket then start to pay off you credit cards and other debts as quickly as possible.

If you’re at 50% or higher then warning signs are flashing and sirens are wailing. You must improve your ratio quickly or you’re going to be in big trouble. If you don’t know how to solve the problem yourself then see a credit counselor right away. You’re staring debt settlement and bankruptcy in the face.

It’s All Relative.
The above information will have hopefully given you a good basic understanding of how debt heath is figured out, but front-end and back-end DTI metrics are relative.

If you have young children that you’ll have to put through college then you should keep your debt ratio lower than a couple with no children, or whose children have finished their education.

If you have really little credit card debt, and don’t have and auto loan or much other debt then you can allow yourself the luxury of a higher ratio.

About the Author
The author of this article was a film producer, and award winning film sound editor for many years. He has long been interested in finance and economics, and one of his websites -> is for folks that need $1000 – $5000 quickly, with most applicants getting their money within 48 hours.