When you're applying for a mortgage loan, auto financing or personal loans, your lender will look at your direct debt ratios to determine whether you have enough money coming into your bank accounts every month to afford your loan payments. If you have too much debt and too little income, most financial institutions won't want to lend you money.
Debt and Income
Lenders look at both your monthly debt obligations and your gross monthly income when determining whether you can afford the payments on the loan for which you are applying. Your gross monthly income is any income that comes into your household on a monthly basis. For most people, salary makes up their gross monthly income. Monthly debts include everything from mortgage loan and auto payments to minimum monthly credit card payments and student loan obligations.
Debt-to-Income Ratio
One of the most important direct debt ratios that lenders consider is your debt-to-income ratio. In general, lenders don't want your total monthly debt obligations -- including your monthly mortgage payments -- to be higher than 36 percent of your gross monthly income. If this ratio is too high, lenders argue, you'll struggle to make your payments when taking on any new debt.
Front-End Debt Ratio
Your lender might also consider your front-end debt ratio when considering whether you're able to handle any new loan payments. This ratio compares the relationship to your housing costs -- including your mortgage payments, taxes and any housing fees you have to pay -- to your gross monthly income. In general, lenders don't want your housing costs to exceed 28 percent of your gross monthly income.
Fixing Your Numbers
If your direct debt ratios are encouraging lenders to reject your loan applications, you have two choices: You can improve your debt ratios by either increasing your gross monthly income or lowering your monthly debts. Be honest with yourself, even if you do lower your debts or boost your income, ensure that you can truly afford any new debt that you take on, no matter what your ratios say.
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