When it comes to applying for a personal loan, there are various factors that lenders do consider before giving approval to the applicants. Though personal loans are the easiest form of debt available in the market, a borrower still needs to meet the required eligibility criteria for a hassle-free personal loan journey. And, one such prime factor is the debt-to-income ratio, which is considered to be the most important eligibility factor by the lenders. The debt-to-income ratio helps to know the financial capability of a borrower as far as timely loan repayments are concerned. It lets you see how your total monthly debt relates to your gross monthly income. A borrower should maintain a good balance between debt and income and most of the banks usually use 40% as a threshold limit.
What is Debt to Income Ratio?
it is an applicant’s ability to manage debt repayments. It is calculated by dividing the total monthly debt obligations, such as minimum credit card payments, auto loans, student loan and the like, by net monthly income. The ratio is best calculated on a monthly basis. The DTI ratio helps lenders evaluate how much additional debt an applicant’s financial situation will allow him to handle. A low DTI shows you have a good balance between debt and income. Most banks usually use 40% as a threshold limit. Below is a formula for calculating your DTI:
DTI = (Total of your monthly debt payments/your gross monthly income) x 100
Example: Let’s suppose the following. Your gross monthly income is Rs.70,000, and you pay Rs.12,000, monthly as rent, plus Rs.13,000 goes in groceries, and you have no other debt. So, your total monthly payments to cover your debts amounts to Rs.25,000
So Your DTI is=(25,000/70,000)x100=35%
Well, which clearly means he would be able to save around 35% of his monthly income. Thus, can easily repay the personal loan without any default.
The Importance of Debt-to-Income Ratio
Your DTI is an important number to keep an eye on because it tells you whether your financial situation is good or if it is precarious. If your DTI is high, 60% for example, any blow to your income will leave you struggling to pay down your debt. If you are hit with some unexpected expenses (e.g., medical bills, sudden travel plans or your car needs expensive repairs), it will be harder for you to keep on top of your debt payments than if your DTI was only 25%.
Importance of DTI for Personal Loan Eligibility
DTI is typically used within the lending industry. If you apply for a personal loan, a lender will look at your DTI as an important measure of risk. If you have a high DTI, you will be regarded as more likely to default on a personal loan. If you apply for a loan, your DTI will be calculated as part of the underwriting process.
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What is a Good DTI Ratio
However, different lenders have different criteria related to DTI. But if experts are to be believed a DTI of 40% or more is an indication of financial stress. So, it would be advisable to keep your ration at or below this threshold limit, however the lower, the better.
Tips to Reduce your DTI Ratio:
- If you reduce your EMI amount, your DTI ratio will go down. This is possible when you opt for a longer tenure for loan repayment.
- An increase in your gross income also brings down your DTI ratio. This could happen if you have any additional source of income or when your salary increases.
- Do not take fresh loans until you pay off the current ones. Any increase in debt increases your DTI ratio.
- Reducing your other fixed expenses can also have a positive effect on your DTI ratio. Don’t make unnecessary purchases until your debt is repaid. The amount saved could be used for down payments or prepayments of your loans.
- Keep a close watch on your expenses and your DTI ratio. This will help you track any expenditure pattern that is pushing up your DTI ratio and take remedial measures.
Always make sure that your DTI ratio stays below 40% to maintain good loan eligibility. Good financial planning can help you achieve a healthy DTI score. However, other eligibility factors like Income, Credit History & Credit Score, Job Stability, Existing Financial Liability and Category of the Employer are also taken into consideration by the lenders before approving a personal loan application.