Front End & Back End DTI Ratio

Establishing credit requires a solid long-term history of success repaying loans and other debts.  Young people rely on incremental credit-building opportunities to build the catalogs of consistent credit success required to secure future financing.  Each positive entry is a step toward creditworthiness, providing greater assurances for future lenders.

Starting with the most basic forms of credit: Mobile phone contracts, student loans, credit cards, and store cards, credit histories are built one transaction at a time. Timely payments are the first order of business for repaying any debt, since late payments are entered on your record.  Depending on your lender, some flexibility might be built in to your account, like grace periods for late payments or other considerations.  Eventually though, your propensity for paying late works against you.

Credit History

Creditors also like to see a variety of credit types in your history. Credit card accounts, for example, operate on revolving credit principles where balances are variable each month, and purchases are made on an ongoing basis.  When managed properly, revolving credit is a great opportunity to establish a solid track-record of repayment.  Since there is discretion built-in to your card agreements, managing the balance is in your hands. The longer you juggle repayment obligations successfully, the better you appear to creditors.

Another widely used form of credit does not allow balances to revolve around continuing purchases.  Instead, installment loans like mortgages and vehicle financing are paid back on regular schedules, with consistent payments over time.  Credit success repaying installment loans is another positive input for future borrowing, illustrating your ability to make consistent payments over time.

Late payments are detrimental to your credit rating, or score.  Even utility companies eventually share delinquent account data with credit reporting agencies, so a missed water bill payment may work against you.

The Role of Income

In addition to past credit behavior, lenders evaluate your ability to pay back loans before issuing them.  Personal income is an important factor for lenders, especially how it relates to your outstanding levels of debt.

To gauge creditworthiness, and reduce their own levels of risk, banks and other lenders review a comprehensive snapshot of your overall financial involvement, before issuing additional credit.  Mortgages, car loans, and revolving credit balances are carefully considered to determine what you owe, and the level of stress it places on your monthly cash flow.  With your ability to repay in mind, creditors consider each monthly payment obligation individually, before combining your repayments to establish your monthly debt load.

The other half of the equation is comprised of your personal income and repayment resources.  A high debt load is cancelled-out by resources sufficient to cover payments, so either side of the equation cannot be used to determine creditworthiness independently – each must be held-up against the other.

Once determined, your total repayment commitments are blended with your future income expectations to determine your Income/Debt ratio; an important figure at lending time. Balancing income with payables is an essential component of repayment success, so income to debt ratios that don't support future fiscal health are cause for denying credit.  Use income debt ratio calculator to check-in on your personal repayment threshold, providing the same feedback lenders use to grant credit.