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Topics addressed on February 8, 2006:
Balance-to-limit ratio applies only to revolving accounts
Does the balance-to-limit ratio only apply to credit cards, or does it apply to installment loans, such as student loans or auto loans, as well?
The balance-to-limit ratio only applies to revolving accounts, like credit cards, where you have a set limit, but you control the balance by making charges or payments.
The concept of a balance-to-limit ratio doesn’t apply to installment loans, such as student loans or auto loans. Installment loans are made for a specific amount that you repay with set monthly payments. You have no choice in how the account is managed.
However, there is another important ratio that installment loans do factor into. That ratio is called your debt-to-income ratio. It is particularly important in mortgage lending, but can also be a factor in other credit transactions, such as buying a car.
This ratio compares your total monthly payments on all of your debts to your total monthly income. It gives lenders insight into whether you have sufficient income to make the payments on additional debt.
To calculate your debt-to-income ratio, add up the monthly payments for all of your debts including installment loans and credit cards. Divide that amount by your total monthly income before taxes have been taken out. Ideally, the ratio will be less than 35 percent including your monthly mortgage payment, and 20 percent or less if you exclude your mortgage.
Income isn’t part of your credit report. You provide that information when you complete the application. Because income isn’t part of a credit report, credit scores might not consider the debt-to-income ratio. Instead it will be calculated separately by the lender as part of its decision-making process.
Like the balance-to-limit ratio, it is important to keep your debt-to-income ratio low to show that you are not overextended or abusing credit.
While credit scores might not consider the debt-to-income ratio, they do factor in the installment debts and whether your payments are made on time, so you should treat those debts with equal seriousness.
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- The "Ask Experian" team