Banks and credit card issuers
consider a variety of factors when you request an extension of credit.
By far, the most important factor is the Debt to Income Ratio (DIR).
Debt, in this situation has a special meaning. It includes all
sources of potential credit, debt and liabilities that are available
to you. So for example if you have a credit card with a $2,000 credit
limit but usually carry only a $100 balance month-to-month, creditors
will use the $2,000 figure as your debt on that credit card account,
not your actual debt of $100.
Having too many credit cards that you
don’t use can negatively affect your creditworthiness. Such items as
outstanding mortgage balances and school loans are also included in
your Debt calculations. Contrary to popular belief, Stafford
loans and other government subsidized loans are included in your Debt
In evaluating credit worthiness of a
consumer, banks and other creditors calculate your Income by
including all sources of income, including salaries, bonuses, rental
income (if you are a landlord for instance) and benefits you receive
from the government. It is thus advantageous to provide your creditors
with verifiable information on all your income sources. As an aside,
income obtained by illegal means cannot be considered by creditors in
calculations of your Income.
High Debt to Income Ratio is a
warning sign to creditors, and is a likely reason that your request
for extension of credit will be rejected, be it credit card, mortgage
or car loan. From the viewpoint of banks, an optimal DIR is about
20-35%. Surprisingly enough, a very low DIR may also cause your
application for credit to be rejected. In this situation, your past
credit history becomes very important. What the banks want to know is
why do you have so little credit? Is it because you are a bad credit
risk or is it that you did not request credit before.
In evaluating your request for credit,
creditors use your credit profile (also known as credit history).
Aside from the items that were discussed above, creditors pay great
attention to whether you have had a history of late payments. While it
may seem to be quite insignificant if you are late with your payments,
creditors have no way of knowing whether it is a result of oversight
or financial inability to pay, and by default they make assumption
that it is the latter.