Credit Ratio

Definition: The ratio, expressed as a percentage, which results when a borrower's monthly payment obligation on long-term debts is divided by his or her net income (FHA/VA loans) or gross monthly income (Conventional loans).

 A credit ratio (or debt-to-income ratio) basically is the percentage of your income that is taken up by your debt obligations.  Lenders look at this percentage to help them decide whether or not you are a good credit risk.

If applying for a mortgage, lenders look for certain defining financial characteristics about you.  For example, they will want to see that you have a history of full-time employment.  Also, they expect you to have a good credit score.  Lenders also look for certain ratios.  You should have no more than 28 percent of your total income needed for a mortgage payment.  Now this includes the principal, interest, taxes, and insurance.  Also, you should have no more than 36 percent of your total income needed to pay your total debt, including your mortgage, credit cards, or other loans.  This is the credit ratio.

If the mortgage for which you are applying would cause your monthly debts to exceed 36 percent of your total income, you are unlikely to get the loan from the lender.  The lender could decide that it is too great of a credit risk.  However, there are situations in which your credit ratios do not matter as much to the lender.  If you are putting down a sizeable down payment, even greater than 20 percent, the lender may not care as much about the credit ratio since you will have so much of your money already invested in the property.  That makes you less likely to default on the loan.

The credit ratio can be a good reality check when applying for a mortgage.  It is not a good idea to put undo financial stress on yourself by acquiring too much debt.  The credit ratio lets you know just how much of your income is required to pay your monthly debt obligations.