When applying for a loan, the lender will check your debt to income ratio to assess your credit risk. Credit risk refers to the risk you pose to the lender. People with bad credit score is labeled as high risk to the lender because it is very likely that they have financial problem.
It is highly possible that they will not be able to make payment on time. The lender will lose money if the borrower does not pay back. Therefore, to compensate for this potential low-interestharge the borrower a high APR interest fee in return. On the other hand, having good credit score can reduce your debt to income risk.Low income to debt ratio means you can be trusted and the lender will happy to lend the loan at a low interest rate.
Debt to income ratio is a comparison of your existing debt to your household monthly income. They will take a look at your credit history and find out the previous creditors that you borrow money from. Your minimum debt payment must not exceed a certain percentage. The purpose of checking the debt to income ratio is to find out whether you have sufficient cash for making the repayment.
Most lenders follow is the 28/36 rule where your PITI payment must
not exceed 28% of your gross monthly income and the total debt must not exceed 36% of the gross monthly income. Gross monthly income is the total amount that you earn every month including your pay check and other sources of income before tax or other deductions.
To find out your debt to income ratio, the lender have to pull out your credit report. They will requets for a copy of your credit report from the credit bureau. In your credit report, it provides information about the amount of income you receive, the address where you are living, all the debts that you apply and the payment you make and etc. All the information on the credit report are used in calculating the credit risk rating.
You can take the initiative to repair your credit score until it reaches a decent level. To repair your credit score, you must make timely payment for your credit card debts. You can still use your credit card but make sure to keep the credit usage ratio to less than 35% if you want a positive credit report.
It is important that you know that most lenders will only request for the credit report from one of the 3 credit bureaus including Transunion, Experian, and Equifax. Before applying the loan, you should first requets for a free credit report and check it meticulously for any mistake that could possibly be recorded there.