8 Credit Card Offers That Could Backfire Later
Credit card companies have their own interests before yours. Read between the lines before accepting an offer.
Use this free Debt-to-Income Ratio Calculator to assess your overall financial health. Simply enter your monthly income and payments to see where you stand. A high debt-to-income ratio may mean that you have too much debt and need to explore your options for debt relief.
A debt to income (DTI) ratio is an easy way to measure your financial health. It compares your total monthly debt payments to your monthly income. If your DTI ratio is high, it means you probably spend more income than you should on debt payments. You have little leftover for other expenses; this often leads to more reliance on credit cards, which just creates more debt. You should take steps to reduce your debt to get back on track.
A low DTI indicates financial stability. It also shows you have the means to take on more debt if you need to get new financing. Lenders use your debt ratio when you apply for a loan. If your DTI is too high, you won’t get approved.
When you apply for a mortgage or any other type of loan, the lender calculates your future debt to income ratio. The sweet spot for approval is a ratio of 41% or less. Keep in mind that the underwriter assesses your future debt ratio, not the one you have right now. They effectively want to see if your DTI would be below 41% with the new loan payments factored in.
This calculation of future DTI during the underwriting process can get a little complicated. Different types of loans may have special consideration.
Let’s say you apply for a new mortgage. You calculate your DTI and it’s right on the cusp of approval at 39%. However, that’s your current debt ratio.
For your future DTI however, the underwriter would remove your current mortgage payments if you’re selling your house. Then they would add in the estimated payments on the new mortgage. As long as this DTI is 41% or less, you receive approval. If you plan to buy a comparable house to what you own now, you should be fine. But if you want to upgrade to a bigger house with a larger mortgage, they could reject the application.
This is why it’s in your best interest to reduce your debt load as much as possible before a major loan approval. Eliminate student loan debt and credit card debt to fix your ratio before you shop around. It will make the underwriting and approval process much smoother.
When you apply for a debt consolidation loan, the lender will also calculate your debt ratio during underwriting. In this case, your DTI determines whether they deliver the funds to you or disburse them directly to your creditors.
Typically, you have high debt levels when you consolidate. But once you pay off your credit cards it should fix your DTI (that’s why you use debt consolidation). So, the lender will only grant approval on the consolidation loan if they know your credit card debts will be paid off. Sending the money directly to your creditors (direct disbursement) ensures that happens.
One of the few types of loans that doesn’t factor DTI in during underwriting is federal student loans. For these, approval is based on need. Your debt level and credit score never factor in, which means it’s easier to get approved.
The tradeoff is that you can end up with way more debt than you can afford. Students graduate with an average debt level of $35,000 in student loans. Most entry level salaries would lead to a DTI of more than 41% based on that alone.
If you have a high debt ratio, payday loans are often where you turn. The underwriting process for short-term installment loans is different. Neither your credit score nor your DTI matter. But that shouldn’t make you feel good about taking out payday loans. While they don’t consider DTI during payday approval, payday loans DO factor into DTI for other financing. So, payday loans trap you in a cycle of only being able to take out other payday loans. Given the excessively high interest rates, it’s almost never worth it.
Although loan approval requires 41% DTI, financial experts recommend that you should keep your personal DTI below 36% if you’re tracking it. This allows you to easily get approved for new financing, which gives you peace of mind during underwriting. Approval for most loans, including car loans and consolidation loans should be easy. Even mortgage approval will go smoother.
Keep in mind that lower is always better. Even if you have 30% DTI, you should still eliminate credit card debt if you carry balances over each month. Less debt improves your debt ratio, as well as your credit score. It’s a win-win.
If your DTI is within this range, it’s time to eliminate debt. You may not need professional help. In some cases, you can reduce debt within your budget or use a do-it-yourself debt consolidation option. For federal student loans, consolidate them and use a student loan repayment plan.
If you can’t eliminate at least some of your debt effectively on your own, it’s time to explore debt relief.
This is a sure sign of financial distress. If you spend over half your income paying bills to cover your debts, you’re probably struggling elsewhere; you also aren’t like to have anything in savings. It’s time for professional help so you can reduce your debt level as quickly as possible. Otherwise, you could be headed for bankruptcy.