Updated on: 31 August 2023
Published on: 22 August 2023
Debt-to-income ratio is an essential criterion that helps financial institutions evaluate your finances. This figure affects the loan amount and credit card limit that you can get.
When you apply for credit, lenders determine this ratio since it reflects your borrowing capacity. Continue reading to understand the significance of this ratio in your loan application process and learn how to calculate it using the debt-to-income ratio formula.
As mentioned, your DTI ratio is an important metric that impacts your credit score and your ability to borrow funds. It is a percentage of your total debt per month against your total earnings in a month.
Experts recommend that you maintain a 35% or lower DTI figure so you can apply for credit without the risk of rejection. Why? In simple words, this number indicates the percentage of your income that goes towards repaying debt.
No wonder lenders prefer a lower ratio because it means a borrower can afford a new loan and is likely to repay it on time. A higher ratio means that your income may be stretched too thin, and the borrower is less likely to pay EMIs on time and more likely to default or delay repayment. Further, having a higher ratio indicates higher dependence on loans and credit cards. Such borrowers pose big red flags for lenders.
Thus, your debt-to-income percentage affects whether or not your loan application will be approved, and also helps lenders decide on your interest rate. With a lower debt-to-income ratio, you seem more reliable to lenders and can get a more competitive rate of interest on a loan.
Read more about How to improve your credit score
Depending on your ratio of debt against income, here are your chances of availing of affordable loans:
To better understand how this ratio works, you must know the simple formula:
DTI percentage = Total Monthly Debt / Net Monthly Income X 100
Here is an example:
Say Manvi wants to apply for personal loan. To avoid rejection, Manvi wants to check her debt-to-income ratio. Here are her monthly obligations and earnings:
Her total monthly debt = ₹15,000 + ₹5,000 = ₹20,000
DTI percentage = ₹20,000 / ₹80,000 X 100 = 25%
With this ratio, Manvi has a good chance of approval on her personal loan application.
While DTI refers to the ratio for individuals, do not mistake it for debt ratio, which is what applies to companies. The debt ratio formula is total debts divided by total assets.
Since a lower DTI ratio improves your credit score, ensure that you track yours and reduce it when possible. Improving it takes perseverance and patience. With some financial planning, you can lower your debt burden quickly.
Here are some strategies to reduce your debt and improve the ratio.
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A debit-to-income ratio under 35% is considered ideal.
To calculate your DTI ratio, add all your monthly debt payments and divide it by your monthly income and multiply it by 100.
The general rule of thumb is to keep your DTI ratio under 35%. A higher DTI can adversely affect your chances of getting affordable credit. That being said, a 40% DTI ratio is considered fair.
Yes, with an 11% ratio, you should be able to get credit from any bank or financial institution. However, this also depends on meeting other eligibility criteria.
The debt-burden ratio is the same as the debt-to-income percentage, which is the ratio of your total debt to income on a monthly basis.
Category : Finance
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