Debt-to-income ratios give lenders a picture of how much additional credit or debt you can manage. Not every creditor measures debt-to-income the same way. The amount of debt you can have relative to your income is based on the type of loan you pursue. In all cases, the lower your debt, the better your chances of approval for new credit accounts or loans.
Mortgage Loans
Debt-to-income ratio is a major determinant when applying for a mortgage loan. Mortgage lenders assess your debt to income ratio with and without consumer debt. The amount of debt you have is compared to your gross income. Without consumer debt, your debt-to-income ratio should not exceed 33 percent. However, including consumer debt, your debt to income cannot exceed 38 percent to qualify for a mortgage loan. Lenders view borrowers with too much debt relative to income as a significant risk. If you are applying for a home loan, pay off credit cards and personal debt before completing pursuing financing.
Credit Cards
Credit card companies seek borrowers who present little financial risk. If you manage your credit card accounts responsibly---making timely payments and keeping balances low, you are more likely to qualify for a new credit card account. Responsible credit card management means keeping a low credit utilization ratio. Credit utilization is comparable to debt-to-income when qualifying for a car or mortgage loan. Credit utilization refers the amount of credit you charge relative to the amount available to you.
For example, if you own a credit card with a $100 limit and charge $70, your credit utilization ratio is 70 percent. According to Bankrate, your credit utilization ratio should remain below 30 percent to ensure a positive credit rating.
Car Loans
Auto loan officers consider your debt-to-income ratio to assess whether you can afford to add a car loan payment to your monthly budget. In general, your debt-to-income ratio should not exceed 36 percent when applying for auto financing. CarBuyingTips.com recommends getting your credit balances below 50 percent before pursuing a car loan to avoid getting stuck with a bad credit auto loan. These loans offer significantly higher interest rates and sometimes large down payments.
Considerations
Debt-to-income ratios can have just as much impact on your loan approval status as your credit score. Paying your credit accounts on time is important in raising your score, but if you have too much debt, the slightest financial setback can lead to account delinquency. Stop charging on credit cards and find ways to reduce your spending before pursuing new financing. Bankrate recommends doubling up on your minimum payment to chip away at large debt balances. Avoid major purchases until you lower your debt-to-income ratio to a rate well below the recommended percentages.
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