Knowing Your Debt To Income Ratio
The financial services industry is full of jargon and one of the terms that sounds much more complicated than in reality is the phrase ‘debt to income ratio’. Often abbreviated to DTI ratio, the term simply means a comparison between the income an individual has and the level of personal debts held.
If the DTI ratio is too high, it could indicate that an individual is overstretched and may struggle with their repayments. A high DTI makes you less likely to qualify for a loan.
The DTI ratio is often used by lenders as a factor to help decide whether credit should be extended to an applicant, as it acts as an indicator of the likely chances of repayment.
For example, some-one with a high DTI ratio would be unlikely to qualify for the most competitive deals as the lender may be reluctant to offer market leading cards to someone they believe has a high chance of defaulting.
There are two different types of debt to income ratios – the one that takes housing costs into account, which is known as front ratio and the one that excludes housing expenses, which is known as back ratio. The level generally desired by lenders is 28% for back ratio and 36% for front ratio.
Most lenders will not want to consider offering credit to anyone with a DTI ratio of more than 45%, as this would represent too much of a risk. More specialist lenders may be willing to take a chance on those with a DTI above 45%, but would usually charge a far higher interest rate to reflect the increase in risk.
Anyone with a DTI ratio above 50% is very unlikely to be able to source credit unless there are extenuating circumstances. One exception to this general rule of thumb may be if the individual has significant savings. Those with a DTI ratio of around 50% could still qualify for credit if they had six months worth of savings in a documented account.
So why is knowing your DTI ratio so beneficial?
Knowing your DTI score is like having a peek at your credit file; it gives a glimpse into how lenders will be likely to view an application. Neither credit scoring nor DTI are used in isolation, but companies use both to build up a financial picture and assess risk. The good news is that DTI ratio is relatively easy to improve compared to a poor credit history.
As a DTI ratio just takes into account debt levels and not everyday living expenses, by paying off any straggling debts, it is possible to quickly boost your score. Costs such as food and utility bills are not taken into account.
Anyone considering balance transfers will want to ensure they do not damage their credit file by having applications needlessly rejected. Knowing the DTI ratio will reveal the likelihood of getting an application agreed and indicate whether it would be better to wait until finances are in a better position.
