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Building Credit Cred: Manage your Debt-to-Income Ratio

The biggest part of your credit score is determined by your payment history. Running a close second, though, is the total amount of money you owe to all of your creditors. About 30% of the average credit score is based on the amount you owe on various accounts.

In the world of finance, there's something called the debt-to-income (DTI) ratio. When you apply for a loan (credit), banks use this calculation to determine if you make enough money to afford the payments. There are a couple different types of DTI ratios, but to keep it simple, it's safe to say that to have a good DTI ratio your monthly debts should be less than 35% of your monthly income.

For example, if you make $1,000 per month at a part-time job, your debts (rent, student loans, credit card bills, car payment, etc.) should total no more than $350 per month.

If your total debts are more than 35% of your income, you may find it difficult to get credit, or you might have to pay a higher interest rate on credit you do receive.

 
Although your income is not part of your credit report, and the DTI is not technically a factor in your credit score, most lenders take these factors into consideration. Therefore, it is likely that you’ll be asked to provide about a month’s worth of paycheck stubs or advice-of-deposits forms when you apply for credit.

Got it? Good. Keep your debts low compared with your income.