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Find Out Why Your Income Doesn't Affect Your Credit Score

By Michael Redbourn

Republish: EasyPublish™
Published: 05Aug2009
Word count: 693
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Surprising as it might seem on first hearing, your credit score is simply based on a debt to income ratio, and how big or small your income is, is only relative to your outgoings.

It's Quality And Not Quantity.

Your credit score simply predicts how well you're likely to continue to make payments based on your current level of debt and on you past payment history, and it doesn't attempt to predict how much debt you can afford to pay back based on your income.

Two Different Metrics.

Lenders use different metrics to understand how likely it is that a would be borrower will be able to repay a loan, and the two most commonly used ones are Front-end and Back-end Debt-to-Income (DTI) ratios.

The names are a mouthful, but they simply describe ratios that are used to compare your fixed outgoings to your monthly income, and they don't do a lot more than give the lender a sense of whether you'll be able to honor your new commitments or not.

A high DTI indicates that a large portion of your income will be eaten up by existing obligations, meaning that the higher your DTI is the less likely it is that you'll be able to manage any new obligations.

What Is PITI!

PITI has nothing to do with feeling sorry for somebody, but is a person's monthly housing expenses and they're made up of principal, interest, property taxes, and insurance (PITI).

Front-End DTI.

A front-end ratio is arrived at by comparing a person's monthly housing expenses to their gross (pre-tax) monthly income, and things such as mandatory homeowner's association dues, and mortgage insurance are added to the PITI.

Rather than looking at monthly income and expenses, most lenders will look at annual ones and Front-End DTI is simply a measure of your ability to afford either your current or your proposed housing.

Historically lenders considered a housing figure of 28% as one after which housing would be deemed overly expensive, but this figure has gradually been raised and now stands at 30% in the U.S.

Many private mortgage lenders stretched it to 33% during the mortgage boom, and we know what happened.

Back-End DTI.

Back-End ratio, is essentially the comparison of a person's total monthly debt payments, which is made up of PITI, plus ALL other monthly debt payments, to their gross monthly income.

"ALL", means what is says and it includes traditional debt such as credit card debt payments, auto loans, student loans, medical debt, and any other loans plus child support, alimony, judgments, and any other monthly obligations.

How Healthy Are You?

Anybody with a ratio of 32% will be welcomed with open arms and a smiling face by lenders, because it's a highly conservative debt load for most people and poses very little risk to the lender.

33-36% is also considered very manageable by lenders because the debt load offers very little risk.

37-42% would be considered OK for a short term loan but if you're after a long term one then try to get your ratio down a little before applying.

A debt ratio of 43-49% is high, and is suggestive of future financial difficulties. If you're in this bracket then start to pay off you credit cards and other debts as quickly as possible.

If you're at 50% or higher then warning signs are flashing and sirens are wailing. You must improve your ratio quickly or you're going to be in big trouble. If you don't know how to solve the problem yourself then see a credit counselor right away. You're staring debt settlement and bankruptcy in the face.

It's All Relative.

The above information will have hopefully given you a good basic understanding of how debt heath is figured out, but front-end and back-end DTI metrics are relative.

If you have young children that you'll have to put through college then you should keep your debt ratio lower than a couple with no children, or whose children have finished their education.

If you have really little credit card debt, and don't have and auto loan or much other debt then you can allow yourself the luxury of a higher ratio.

The author of this article was a film producer, and award winning film sound editor for many years. He has an interest and natural flare for economics, so if you need a loan but are worried about your credit score, then go check out -> Need Credit Now because if offers a long list of lenders that provide, Auto Loans, Personal Loans and Mortgage Loans, plus Guaranteed Credit Cards to those with bad credit.

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