Home Discover Journals What is the debt-to-income (DTI) ratio and how to calculate it?

What is the debt-to-income (DTI) ratio and how to calculate it?

By Finserv MARKETS - Aug 27,2019
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Debt-to-Income Ratio and How to Calculate It

You may have thought, “Why I should worry about the debt-to-income (DTI) ratio when my credit score is good enough?” In reality, the DTI ratio is as important as your credit score and lenders scrutinise this carefully.

It makes plain sense to consider the DTI ratio as an important parameter to judge your creditworthiness. By looking at your DTI ratio, lenders are simply trying to get an answer to their following concerns: Is this individual maintaining a healthy balance of credit and income? Can he pay off the loan or credit on time with his present income and liabilities?

The DTI ratio is a personal finance metrics that helps lenders assess your capacity to manage expenses and make timely repayment of debts. Though credit scores and history are important, it is not a fool-proof method to assess an individual’s repayment ability. With credit scores, one can judge the past repayment history of the borrower, but it is not a good measure of how the borrower will repay his debts in the future. That is where the DTI ratio plays an important part.

Debt-to-income ratio along with credit scores and credit history creates a holistic picture of a borrower’s creditworthiness and is a more effective tool for assessment.

What is DTI ratio?

Debt-to-income ratio is simply your total monthly debt repayments such as EMIs on a home loan or personal loan, business loan, minimum credit card payments per month, rent etc., divided by your net monthly income. Lenders usually calculate your DTI ratio on a monthly basis and this figure helps them decide whether you can handle an additional debt burden with your current liabilities and income when you apply for a loan.

For example – if your monthly income is Rs.1 lakh and you make monthly debt payments of Rs.25,000, your DTI ratio is 1:4 or 25%.

How to calculate DTI ratio?

Calculating the DTI ratio is very simple. You just divide the total monthly debts and expenses by your net income and multiply it by 100.

You can consider the following debts and expenses:

  • Car loan

  • Home loan

  • Student loan/Education Loan/Personal Loan for Education

  • Credit card Payments

  • Monthly Rents

You can consider the following as monthly income:

  • Take home salary

  • Dividends

  • Interests

  • Earnings from shares

  • Rental income

Next, add the net total amount of debts and expenses and the total amount of your monthly income. Then divide the total debt by total income and multiply it by 100 to arrive at a percentage figure.

What is a healthy debt-to-income ratio?

What is the magic figure that shows that you have a good DTI ratio? Well, there’s no consensus on an exact figure, but most banks usually prefer DTI ratio of 40% or below. [1] Most lenders will consider anything above 40% as risky yet there are some financial institutions that may offer loans to individuals with a DTI ratio above that threshold.

How to improve your DTI ratio

If your loan has been rejected due to a high DTI ratio even though your credit score was good, you have two options to improve or reduce your DTI ratio. One is to lighten your debt burden and the other is to increase your income; though the latter method seems easier said than done.

Here are a few things you can do to reduce your debt burden:

  • Pay off your credit card bills on time and gradually make prepayments for smaller EMIs and target bigger ones as you go.

  • Use the debt snowball method. In this method you actually start paying the smallest debt first and then gradually move towards the bigger debts.

  • No matter how small, avoid increasing your debt.

  • Take up additional or freelance work to increase your income if your employer allows it.

  • Cut down on extra and unnecessary expenses.

  • Go for debt consolidation. With a Bajaj Finserv personal loan for debt consolidation at Finserv MARKETS, you can consolidate all the different loans to a single lender and pay off all the debt and convert the personal loan into flexible and lower EMIs. As your EMIs will go down, your DTI ratio will come down as well.

  • Lastly, you can opt for a Bajaj Finserv personal loan balance transfer of your existing personal loan to improve your DTI ratio. With lower interest rates and longer tenures, you can bring down your monthly outflow of EMIs thus reducing your DTI ratio.

A Bajaj Finserv personal loan for debt consolidation comes with flexible borrowing and repayment options. You can also take advantage of pre-approved offers with superfast processing and attractive personal loan interest rates. [2] A high DTI ratio should be a cause of concern for you because it signifies that your finances are stressed. You should try your best to keep your DTI ratio at a minimum level and try to increase your savings.

Also get to know about how to get a personal loan with low credit score.

Finserv MARKETS, from the house of Bajaj Finserv, is an exclusive online supermarket for all your personal and financial needs. We understand that every individual is different and thus when you plan to achieve your life goals or shop for the gadget of your dreams, we believe in helping you Make it Happen in a few simple clicks. Simple and fast loan application processes, seamless, hassle-free claim-settlements, no cost EMIs, 4 hours product delivery and numerous other benefits. Loans, Insurance, Investment and an exclusive EMI store, all under one roof – anytime, anywhere!

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Bajaj Finserv Direct Limited ("BFDL"), erstwhile Bajaj Financial Holdings Limited is a registered corporate agent of Bajaj Allianz Life Insurance Company Limited and Bajaj Allianz General Insurance Company Limited under the IRDAI composite registration number CA0551 valid till 10-Apr-2021. BFDL also renders services to Bajaj Finance Limited (‘BFL’) and Bajaj Housing Finance Limited (‘BHFL’) (referred hereinafter as ‘Lending Partner’) in sourcing of customers, providing preliminary credit support activities, fulfilment services and post-acquisition customer services related to lending business. Registered Office: Bajaj Auto Limited Complex, Mumbai – Pune Road, Akurdi, Pune – 411 035 CIN: U65923PN2014PLC150522