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Your Maximum Debt
Capacity and the Debt to Income Ratio
There is
a maximum amount of your monthly income with which you
should repay the debt you incurred. Naturally, this in
turn, would be related to the maximum amount of debt you
carry. Lenders and credit agencies call this the debt
to income ratio.
This is
easily calculated, if you include all the amounts that
fall under the headings shown below:
| Monthly Debt Servicing
Costs |
Monthly Income |
 |
Mortgage
(incl. Property Tax and Insurance) of
Rent Payment |
|
Total
Monthly net (after Tax and Deductions) Income
- if you want to be conservative, you
should exclude bonus payments! |
|
Payments
on Home Equity and other Property
related Loans |
|
Monthly
Income from activities that would be
shown on a US Tax form 1099 |
|
Car
Payments |
|
Other
Income (exclude windfalls, lottery
winnings etc) such as interest etc |
|
Credit
Card Payments (at the minimum times
two the minimum Payment) |
|
Child
Support and Alimony payments being paid
to you. |
|
Other
Loan or Note Repayments, payment
to judgements or liens |
|
|
|
Child
Support and Alimony Payments (if any) |
|
|
|
Student
Loan Repayments |
|
|
|
Total
Monthly Debt Service Payments (A) |
|
Total
Monthly Net Income (B) |
Now, divide
(A) into (B) and multiply the result by
100. That will give you the percentage
of your monthly income you pay in debt
servicing costs. It is also known as the
| Monthly
Debt Service to Income Ratio. |
|
|
|
You
should be aware that the debt servicing payments should
include any payment arrangements you
have made, such as, for instance, payments to
hospitals or dentists for past treatments. The
higher the percentage of debt servicing payments,
the greater a credit risk you become. Future and
existing lenders, such as credit card companies
will look closely at that relationship, when they
review your credit worthiness. |
How Lenders
view and interpret your Debt to Income Ratio
When you
apply to a financial institution for a loan or a credit
card, the credit or loan officer will look
closely at your current income and your current debt. The
Debt to Income Ratio will be a major factor
in the recommendation of the credit officer about your
ability to repay any proposed granting of credit.
| 0-35% |
This is a
good ratio that will result in
acceptable credit conditions and interest rates.
Most credit analysts and credit officers will
recognize your ability to manage your debt. You might
even get lower interest rates if your ratio is
below 25% of monthly income. |
| 36 - 40% |
These are
border line ratios. You may have to provide some
plausible reason to a lender why your ratio is
that high and they may want to see an
improvement over a specified time. A
ratio in that range could now (2012)also
result in a reduction of your credit card limits
during the next financial review of the lender. |
| 41+ % |
Such a
high ratio will have a profound effect on
your FICO Credit Score. Many financial
institutions will no longer consider your credit
application and if they do, your interest
rate will be considerably higher.
Lenders may also ask for additional
securities, before they extend credit. |
Checking your ratio regularly will help
you manage your finances better, which should result
in a better credit score and lower interest rates.
You can
get some more information about personal credit
management from these books from amazon.
| Books on
Personal Credit Management from amazon.com |
|
