15 November 2016

What is a debt-to-income ratio?

You might know the value of looking after your credit score, but few people understand what your debt-to-income ratio can tell you – and your potential lenders.

When you apply for credit, a responsible lender will want to make sure that you can afford to keep on top of payments. That’s why we use credit scores to gain a picture of your repayment history and decide whether you’re a trustworthy borrower.

What can your debt-to-income ratio tell you?

Most lenders will also check your debt-to-income ratio, which is a percentage that shows how much of your monthly income goes towards paying off debts such as your credit card and mortgage.

Instead of acting as a financial CV, as your credit score does, your ratio compares your essential outgoings to your income to help lenders to assess your ability to manage monthly repayments. You can also use it yourself to check whether you’re in good enough financial shape to take on a new loan.

Lenders will expect your monthly repayments to be covered by a certain percentage of your income. If your debts are less than this portion of your income, you may be allowed the loan. Aim for a debt-to-income ratio of less than 45%, especially if you’re applying for a mortgage, but the lower the better.

How to calculate your ratio

  1. First, add up your recurring monthly debt – this includes rent or mortgage payments, car loans, child support, credit cards and student loans. Some banks and building societies will include the new loan, so it’s best to include your expected monthly payment.
  2. Then tot up your monthly income. As well as your gross wages (before tax and national insurance contributions), don’t forget to include freelance income or child benefits.
  3. Finally, divide the monthly debt by your monthly income and multiply it by 100. So, if your debts came to £1,020 and your monthly income was £2,916 your debt-to-income ratio would be a healthy 35%.

Why should you know it?

It’s not just lenders who can benefit from checking your debt-to-income ratio, it can be a good way to check whether you need to tidy up your finances before applying for a loan or mortgage. For example, if you find your ratio is higher than expected, you might want to lower your debts or increase your income – or both – to increase your chances of being accepted for a mortgage or personal loan before you apply. 

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