Whether you want to borrow money to purchase a car, a home or for any other reason, prospective lenders want to see how well you can manage debt. One common measurement tool lenders use is your debt-to-income ratio. Opening an additional line of credit could negatively affect this ratio and possibly decrease your chances of securing a loan.
Debt-to-Income Ratio Defined
Your debt-to-income ratio compares the amount of your monthly debt payments to your gross monthly income. For example, if your monthly debt obligations for items such as mortgage, credit card and car payments total $1,000 and your gross monthly income is $4,000, your debt-to-income ratio would be 25 percent. From a lender's perspective, the lower your ratio, the better your chances of obtaining loan approval. According to the U.S. News & World Report Money website, a ratio of 36 percent or less is considered healthy, while a ratio of 50 percent or more requires aggressive debt-reduction steps.
A credit line is a predetermined amount of money that a lender extends to you and allows you to draw from as the need arises. The amount of your minimum monthly payment is based on your outstanding balance at the end of each monthly billing cycle. You can replenish your credit line by paying back what you've borrowed. Common examples of credit lines include a home equity line of credit where you borrow against the equity you've accumulated in your home, as well as revolving credit cards.
Debt-to-Income Ratio Impact
The impact of an additional credit line on your debt-to-income ratio depends on how you use the line. If you don't draw from the line at all, your total monthly debt payments will not increase, so your ratio will not change. On the other hand, if your use of the new line increases your debt payments from $1,000 to $1,200 and your monthly income remains at $4,000, your ratio would increase from 25 percent to 30 percent.
Even if you don't use your additional credit line, its existence can impact your ability to obtain credit in the future. Some of the factors that determine your three-digit credit score include whether you have opened any credit accounts recently and the total number of credit accounts you have. Opening a new credit line just before applying for a home mortgage, for instance, could lower your score and possibly make it harder to get a loan at the most favorable interest rates.
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