Lenders look at two key ratios when determining whether you can handle new debt with mortgage, auto or personal loans: your debt-to-income ratio and front-end ratio. Lenders also consider your three-digit credit score when determining whether you're likely to default on your new loan payments.
Debt-to-Income Ratio
Before lending you money, financial institutions want to make sure that you'll be able to make your loan payments on time. To determine this, they look at the amount of monthly debts with which you're burdened and the size of your gross monthly income. Using this information, lenders calculate your debt-to-income ratio. In general, lenders want your monthly debt obligations, including your monthly mortgage payments, to equal no more than 36 percent of your gross monthly income. If new debt will push your ratio higher than this, financial institutions may hesitate to lend to you --- they won't think that you can sustain so much debt.
Front-End Ratio
Lenders also consider your front-end ratio when determining whether you can afford to take on new debt. This ratio is similar to the debt-to-income ratio, but it only considers the relationship between your housing costs and your gross monthly income. Lenders prefer that your monthly housing costs --- a number that includes your mortgage payment, interest and any housing fees that you pay --- don't exceed 28 percent of your gross monthly income.
Credit Score
If you have a high three-digit credit score, lenders might be willing to lend to you even if you already have a high level of debt. That's because a high score indicates that you have a long history of paying your bills on time. In general, if your credit score is 740 or higher on the popular FICO credit-scoring scale, lenders are usually more willing to work with you, even if your debt ratios are too high.
Making Improvements
By reducing your monthly debt and boosting your gross monthly income, you can improve your debt ratios. This allows you to take on more debt. Be careful, though; You don't want to take on more debt than you can handle, even if financial institutions are willing to approve you for more of it.
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