When Qualifying for a Loan: It’s Not Your Credit Score that Matters — It’s How Much Debt You’re Carrying

Probably the most frequent question I get from prospective clients is: “Will bankruptcy hurt my credit score?”

It’s a fair question, but I usually find it a little amusing. It’s a bit like the man who’s drowning worrying about how he’s dressed.

For most people, by the time they see a bankruptcy attorney the financial problem is extreme — the garnishment has begun, the foreclosure is imminent, the summons has arrived setting a court date, or the collector calls are now coming every hour. And, of course, at this stage, the person’s credit score is in the tank. It cannot get worse.

By clearing away debt, I explain, they will improve themselves to get a loan.

A recent survey of credit-risk managers at lenders by credit-score giant FICO, reported in the Washington Post, confirms what I have been saying all along: When it comes to qualifying for a loan, it’s the amount of debt you are carrying, not your credit score that matters most.

“Researchers asked a representative sample of them what single factor makes them most hesitant to fund a loan request — in other words, what’s most likely to prompt them to say no.

Tops on the list? Surprise, it’s not your credit scores. And it’s not how much you’ve got for a down payment or what you have in the bank. It’s your DTI — your debt-to-income ratio. Nearly 60 percent of risk managers in the FICO study rated excessive DTIs as their No. 1 concern factor. . . “

Again, I repeat, for 60% of bankers it’s the amount of debt the credit applicant is carrying that is the disqualifier, not the credit score!

“Debt-to-income ratios for home loans are the most direct indication about whether you are going to be able to afford to repay the money you want to borrow,” says the article.

Basically, bankers look at two ratios to determine whether they will qualify an applicant for a home loan.

The first ratio looks at the ratio of the monthly payment for the loan you seek to your gross monthly income. Generally, lenders do not like to see a ratio for this of greater than 28%. Basically, they don’t want you to buy a bigger house than you can afford.

The second ratio, the so-called “back end” ratio, is a ratio of your monthly recurring debt payments against your monthly gross income. The recurring debt payment total includes the proposed housing payment as well as your credit cards, car, student loans and payments on other debts. For most lenders, this ratio cannot exceed 43%. This is why amount of debt you are carrying can be such a deal-killer when applying for a loan.

For a lender, who cares about a bankruptcy in the past, it’s the applicants current debt load, as well as income that matters.

If you have financial problems and are looking for guidance, contact us for a consultation. We’ll ready to help.

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