A client recently went to the bank to talk about opening a line of credit. She filled out an application, then the banker entered the information into his computer and reviewed her credit score. But her credit score was just one piece of the puzzle; there were other numbers he was interested in, too.
That’s right, a credit score is only part of the calculation that creditors use to decide whether or not lend to you.
While each creditor has their own decision-making guidelines, there are two non-credit score numbers that nearly all creditors also pay attention to.
Total Debt-to-Income Ratio
This is the measure of how much total debt you currently carry versus the amount of income you earn. The assumption on the part of the creditor is: The higher your income, the more debt you can carry because you are more likely to pay it off. In this ratio, they are paying attention to unsecured debt, like credit cards and outstanding lines of credit, and they may also factor in secured debt, like your mortgage. For example, if you have $50,000 in credit card debt and you make $50,000 per year, they can see that it will take an entire year’s worth of income just to cover your credit card debt. Or, if you have $500 in credit card debt and you make $50,000 per year, they can see that you have a much more favorable total debt-to-income ratio.
Debt Utilization Ratio
This is the measure of how much available credit you have compared to how much of that credit you’re using. So if you have a credit limit of $10,000 on one credit card and you have $1,000 in debt on that card, your utilization is 10%. (Of course, this is just for one card; they take into consideration all of your available credit and debt). The lower your utilization, the better, because it shows that you do not need to use all of your available credit.
These two numbers are important to creditors because they help show how much debt you are using and how able you are to meet your debt obligations with your current income. They use that information, along with your credit score, to help them determine your creditworthiness.
Armed with this information, you can help to improve these ratios by paying down debt, working on increasing your income, and increasing your credit limit. Although you can’t “game the system” by doing this, it’s helpful information for you to understand what factors are influencing your lender’s decision-making.