If you want to buy a house, car or any other major item, you probably need a good credit score. Unfortunately, though, if you have too much credit card debt, your credit rating may be in the basement.
While credit bureaus use a complicated and somewhat secretive formula to calculate credit scores, they always consider a person’s debt-to-income ratio.
A mathematical calculation
Your debt-to-income ratio simply compares your outstanding debt to how much you earn. When calculating the ratio, credit bureaus use all your debt. This includes the following monthly expenses:
- Mortgage or rent payments
- Alimony, child support or other court-ordered payments
- Car, educational and other loan payments
- Credit card minimum payments
- Any other debt you owe
After adding your monthly debt payments, divide the total by your gross monthly income. This is how much you make before taxes. The resulting quotient is your debt-to-income ratio, which you can express in a percentage.
A magic number
The U.S. Consumer Financial Protection Bureau notes 43% is the magic debt-to-income ratio. If you have a higher one, you may have trouble securing a mortgage or borrowing money for other reasons.
An improvement plan
If you want to improve your debt-to-income ratio, you likely have a few options. First, you can pay off outstanding balances, lowering how much debt you have. You can also increase your income by looking for a job that pays more.
Alternatively, you may want to consider filing for Chapter 7 bankruptcy protection. If you go this route, many of your debts may discharge. While your credit score may take an immediate hit, a better debt-to-income ratio may help it in the long run.