Consumers with a high debt-to-income (DTI) ratio can breath a sigh of relief -- credit scores do not factor in their DTI ratio. However, a high DTI also means you might not qualify for any loan. The DTI may be as important as a credit score in determining credit approval and often is the decisive figure on a credit application.
Relationship
DTI does not affect credit score calculations because income is not reported to credit reporting bureaus, and those bureaus cannot confirm a consumer's income. DTI and credit scores usually have a direct relationship, however. That is, the higher your credit score, the higher your DTI can be for you to still receive credit approval. Also, the lender might use information on your credit report to calculate your monthly debt payments.
What is a Good DTI?
DTI typically takes precedence over credit scores in credit approval decisions, because DTI quantifies an ability to pay, whereas credit scores calculate a willingness to pay. If a DTI is as high as 38 percent, according to the Michael Bluejay website, few lenders will approve credit for a prospective borrower, because this leaves very little income left to pay for expenses and other essentials not included in a DTI ratio, such as grocery bills. Bankrate reports that certified financial planner Diane McCurdy recommends keeping your DTI below 30 percent.
Considerations
Some credit scoring systems can incorporate a DTI ratio, known as application-scoring models. These usually are custom-made formulas for a company's use only, and they are not used by credit bureaus. Thus you should keep a DTI ratio as low as possible.
Tip
If you have a high DTI, you should find ways to cut spending in your budget and divert those resources to paying down existing debt. Credit card debt typically may be the first thing you should tackle, because it usually has the highest interest rate. When you cannot cut spending and have a high DTI, a new large loan, such as an auto loan or mortgage, is probably too risky at the moment.
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