Debt To Income Ratio...30%...huh?
Everyone talks about this ratio number...30%? I might not even have asked the question right in my title. How do I figure out this 30% ratio number and what does it mean exactly. I have OK credit(650) but was told about this. I would rather sound like a dummy than look like one, that is why I am writing to you. 
I am pretty sure it means that you take all of your monthly expenses divided by your monthly income and that number is your debt to income ratio. Most banks I have talked to like that number to be 30% or less. I think that is right but could someone say for sure.
Okay, this is how it works, the lender (or creditor) will pull your credit. They look at several different things. They will look at how many credit cards you have, the balances and how many months you pay the minimum balance due. they will take your bills, all of them, and add them together and use the appropriate formula to see what your available funds are. Available funds are what you have after all bills are paid. Then they can see what percentage of your income goes to bills. This percentage is what you are asking about. The key is to keep your bill adverage down to less than 30%. That will make you what's known as an A- to B consumer. 20% is ideal. NEVER charge more on your cards than you can pay off in one to two months time. The more credit cards you have, the worse it is. Even if these cards are empty, the min. balance due is still calculated into your percentage.
Do you understand now, or have I made it worse?
Thanks for the advice so far and yes it helped. But here is another question. I just received 2 more credit cards in the mail for $300.00. I was going to use these for emergency funding for RE business, but now I am wondering, should I cancel them? I do have 2 others already, one with a max of $10,000 and $600.00. Should I cancel them before I activate them?
When steena says to " take your bills, all of them", make sure you include your monthly housing expense (rent or mortgage payment), your monthly car payment, and your monthly student loan payment, in addition to the minimum monthly payment requirements on all your open credit cards.
This is your total monthly liability. The lender would like to see this amount less than 30% of your gross monthly income (before withholdings).
Yes! yes! yes! Thank you Dave T for catching that!
About cancelling them, two to three credit cards is okay, (one to two is best)more than that and you get in trouble. Just a thought, ever notice that when you have "emergency funds" set up......one "emergency" after another just seem to happen?
(or is that just me?)
Remember, when it comes to credit cards ......less is better!
Steena, GREAT advice!
[addsig]
You have been given conservative but misleading advice. I am a lender and investor.
When we do loans the ratio at the most conservative level is 28/36
What that means is your house payment should be 28% of your gross income and house plus the minimum due on all other credit report debt is 36 %. These numbers are almost outdated and many loan programs go way over these numbers. A good loan officer/Broker will be able to explain all the various options.
Never is the credit available calculated for purposes of ratio.
However it does affect your credit score.
A simple calculator with division will give you the number. Plus lender web site calculators may also walk you through and do the figuring while you see and understand it.
David Evanson,
Eugene/Springfield, Oregon
Evanson is right, You won't be turned down if your ratio is a little higher than our conservative numbers. However if you want to get to a 750 or higher and get all the perks that come with that then you should be conservative with your ratio. If it looks like you are dependent upon the credit you already have then you are a higher risk to a potential lender.
It sounds like you are talking about the 28/36% ratio. Most lenders prefer loan candidates to have a housing ratio that represents 28% of their gross income and a total expense ratio that represents 36% of their income. In reality most lenders will take allow neighborhood of 55% of your expenses to go to your gross income. Which means you have 45% to spend on other bills. We know that is not true, because that is your gross and you are only spending your net, so in effect you may only have somewhere around 30% of your income to spend on other stuff -- you know the money you need to live on.
Tish Henderson
www.epower3.com
28/36?!?! Of your Gross income. Now deduct out what the tax man taketh, then take out what the wife taketh, then you have nothing left!
Just remember, the lower you keep your ratio (30% or lower) the faster you get out of debt, the longer you stay out of debt, and then you don't end up as one of the foreclosures in my paper and I am sending you nice post cards to buy your house.
When the banks were tighter on the percentage, there were fewer foreclosures. Makes sense now doesn't it????
Best,
Ryno
Honestly, as one who has deliberately studied and experimented with "what happens when..." ...with Fair Isaac's scoring models (and some lenders proprietary models), I have to say this: if you don't use your credit, your score will not be very high. I don't mean run up huge balances - but prospective lenders want to see you use it. They want to see you charge on it, revolve on it, and they want to see a payment pattern over a period of time.
Not only prospective lenders, but your current creditors. Take one card, and experiment with it (preferably not Capital one) - use it for everything you can over a period of time - say 4 months - make BIG payments, but revolve some of it. Then pay it all off at once. Yes, you'll pay interest (hopefully, if you're smart, not much) - the card company will make some money. BUT they will love you.
They'll often give you unsolicited credit line increases, and special deals, like 0% for a year (what could you do with that?). And most of the time, after establishing this kind of pattern with them, they will pretty much do anything to keep you - so you can ask for the overall interest rate you want.
Your credit score will shoot up. You can get anything, they all will want you.
It's not a matter of getting deeply into debt with no way out, it's a matter of being smart and using credit as a tool to get where you want to be. If you charge all your monthly expenses, don't go spend the cash too.
Everything has been pretty much covered but just remember this as a guide:
The higher the backend ratio (28/36 with 36 being the backend or bottom ratio) the higher the interest rate.
Not as rule of thumb in general but a guarantee when you go over 43-45%
(depending on the lender )because when you do this you are now in what they call SUBPRIME COUNTRY!
Translation = HIGHER RATES.
With a score like yours you may want to explore your options (ARM, interest only loan, etc.)
But for someone who has the ability to pay but for whatever reason(s) has a
lower score they can go as high as 65%.
Quote:
On 2003-11-21 12:51, qball31 wrote:
Everyone talks about this ratio number...30%? I might not even have asked the question right in my title. How do I figure out this 30% ratio number and what does it mean exactly. I have OK credit(650) but was told about this. I would rather sound like a dummy than look like one, that is why I am writing to you. <IMG SRC="images/forum/smilies/icon_confused.gif">
Well everyone has had their take on your question but I read it a little differently. Ex: You have a credit card with a credit line of $1000. Do not allow your balance to exceed over $300 (30%) in order to maximize your credit score.
Also from studying my score and reports revolving charges (balance-to-credit line) are weighed the heaviest (credit cards, credit lines, etc.) not installment loan (car loans, etc.) I paid off a vehicle loan in October after having almost 2 years and my score dropped 14 points I paid off to lower my debt-to-income thinking it was a "good" thing and I was penalized!
The Fair Isaacs model seems to be set up on the premise to obtain credit and then deciding who is the wisest with it. Those people are in the 700 + club.
[ Edited by fmmp on Date 01/06/2004 ]
There are actually 2 ratios. One, the "front end" ratio is the ratio referring to the amount of the payment to income. The second or "back end" ratio or "DTI - Debt to Income" ratio is the total of debt owed plus the payment to the gross income. Be wary of using any "SET" figure for that ratio, because every lender has their specific criteria based on their note buying investors requirements. Fannie Mae and Freddie Mac are the two largest secondary market buyers and therefore set the standard for "cookie cutter" loans. Those ratios are still a bit arbitrary, but will generall be: front - 28% , back 38% to 40%. VA and FHA have somewhat the same but may vary depending upon supporting factors. Some lender will go as high as 55% on the backend and my not even look at the front end ratio! Depends upon the debt.
Our experience has confirmed that maintaining substantial availkable credit, while using 5-10% of that amount monthly-revolving, and paying-off each month has yielded FICO scores of 795+...my mort. broker has commented that with more seasoning of perhaps 10 yrs.+, my score could go to 810+...be prudent and continue to buy only what you can manage without duress.
The "traditional" 28/36 ratios are very old school in conventional underwriting. Very few lenders stick to these ratios.
We put all conventional loans through the automated underwriting systems of Fannie Mae and Freddie Mac. You'd be amazed how the ratios are pushed, or held back, for many factors.
I've received Approve/Eligible's on 100% LTVs with a 58% debt ratio through Fannie. The score was good, stable employment, but good funds. In Fannie's system, funds outweigh a lot of credit issues. Also, Fannie's system does not use a FICO score, but imports each trade and assigns their own weighting, layering the risk with all the other factors in the file.
Rates are not "higher" in such scenarios, but get the standard Fannie/Freddie rates with no ppp's either.
Any broker or lender worth their salt will first put a loan through the agencies AUS before even trying subprime. And my post doesn't even cover the A- programs of Fannie and Freddie (I'll save that for another time).