Debt to income ratio is an appropriate way of calculating how much debts you owe. Lenders, while sanctioning a loan, consider the value of your debt to income ratio, as important as your credit score. Usually, debt to income ratio is calculated by dividing your total monthly debt by total gross monthly income.
Your total monthly debts include your mortgage loan payments, car payments, alimony, house payment or lease, credit card and other revolving credit balances and child support. While calculating your total debts, you may let off the utility bills, grocery, telephone and utility bills that you may pay in the next month.
Basically your debt to income ratio is an appropriate way of calculating how much of your monthly income is paid for your debt payments.
The lenders use this value to analyze your credit worthiness. This value helps them to judge, how much money they can lend you without risk. They apply a basic standard rule; 28/36 while analyzing your debt to income ratio.
What is the standard 28/36 rule from the lender’s eye?
| Value of debt to income ratio | Lender’s conception of the borrower | Status of loan approval |
|---|---|---|
| 28% and below | Financially sound and credit worthy | Easy |
| 28% – 36% | Average financial status | Nor easy neither too difficult |
| 36% and above | Financial status is poor and less credit worthy | Doubtful. Even if it is allowed, he may have to pay high interest rate. |
Why do the lenders consider the value of debt to income as important as your credit score?
The lenders usually prefer the valueof debt to income ratio more than your credit history. They feel that the credit score reveals you efficiency in credit management; it does not reflect your income. The debt to income ratio is the best way to analyze your total income. So, they give significant importance on the figure of your Debt to income ratio, as an important document to approve your loan amount. The mortgage lender stress upon this figure, because it helps them to calculate PITI (principal, tax, interest and insurance) the four components of a mortgage payment. They can turn down your application, even if you have a perfect payment history. Even when you’re looking for a debt consolidation loan to alleviate your debt burden, lenders can take your debt to income ratio into consideration before approving the loan.