What is (DTI) Debt to Income Ratio? How to Calculate Debt To Income Ratio

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16 JANUARY, 2024

Maintaining a balance between your income and debt is essential in the complex world of personal finance. This balance is best captured by the debt-to-income ratio, a measurement that lenders use to assess your financial well-being. Having an understanding of this ratio and how to manage it effectively can make a huge difference, especially when considering taking out a Personal Loan.

What is Debt-to-Income Ratio?

The debt-to-income ratio is the ratio of all your monthly debt expenses to your gross monthly income. In other words, it is the percentage of your monthly income that goes towards repaying your debts.

The debt-to-income (DTI) ratio essentially compares your debt payments to your gross monthly income. It serves as an indicator of how you handle the repayments for borrowed money. In this section, we will understand what the DTI ratio is in detail.

What is Included in Debt-to-Income Ratio: Typically, it includes monthly debt payments like credit card bills, loan EMIs, and other liabilities, but not your everyday expenses.
Significance in Financial Health: A lower DTI ratio indicates a good balance between debt and income, making you more attractive to lenders.
Impact on Future Borrowing: A favourable DTI ratio not only reflects your current financial stability but also impacts your ability to secure loans in the future. Lenders often use it as a threshold criterion, making a lower DTI ratio crucial for future financial planning and borrowing.

How is the debt-to-income ratio calculated?

The debt-to-income ratio is calculated using a simple formula, as shown below.

Debt-to-income ratio = (Monthly debt payments ÷ Gross monthly income) x 100

Knowing how to calculate the debt-to-income ratio is important, and fortunately, it is a straightforward process:

The debt-to-income ratio is calculated using a simple formula, as shown below. List Your Monthly Debts: Sum up your monthly payments, including EMIs for existing loans, credit card payments, and any other recurring debt payments.
Determine Your Gross Monthly Income: This is your monthly income before taxes and deductions.
Perform the DTI Calculation: Divide your total monthly debt by your gross monthly income. Multiply the result by 100 to get a percentage. This is your DTI ratio.

So, for example, let’s say you earn a gross monthly income of Rs. 1,00,000. And this month, you pay the following sums to settle your debts or liabilities.

Home loan EMI = Rs. 20,000
Car loan EMI = Rs. 6,000
Credit card dues = Rs. 12,000

In this case, your total monthly debt payments come up to Rs. 38,000. This means your debt-to-income ratio will be calculated as follows.

DTI Ratio:

= (Rs. 38,000 ÷ Rs. 1,00,000) x 100

= 38%.

How to Figure Out the Debt-to-Income Ratio for Loan Eligibility?

When you apply for a Personal Loan, lenders will scrutinise your DTI ratio to assess your loan repayment capacity. A high DTI ratio might signal financial strain, whereas a lower ratio suggests a healthier credit profile.

Personal Loan Eligibility: Lenders prefer a DTI ratio of 40% or lower as it indicates a balanced debt-to-income level.
Using Personal Loan EMI Calculator: This tool helps you understand how the personal loan EMI will affect your DTI ratio, aiding in making informed borrowing decisions.

What is a good debt-to-income ratio?

Banks and other lenders look at your DTI ratio to determine how capable you are of repaying a new loan you take. As a general rule, the higher your debt-to-income ratio is, the more difficult it will be for you to repay a new debt. This is because a huge part of your income will already be going towards repaying your existing liabilities.

Here is a closer look at what different ranges of the debt-to-income ratio may indicate to a potential lender.

DTI Range	Details
< 36%	Considered to be good since your debt is within manageable levels
36-42%	May be a bit concerning, but you can still get loans without too much trouble
43-50%	Could indicate a concerning debt situation, and some lenders may reject your loan applications for more credit
>50%	Highly troubling levels of debt that make it hard to get new loans through banks or financial institutions

So, the bottom line is that it is advisable to keep your DTI ratio below 36%. That way, you will not be under any undue financial stress, and repaying your loans will be easier.

Why is the debt-to-income ratio important?

Your DTI ratio impacts several areas of your personal finance. It is one of the key metrics that determines many aspects of the credit facilities you are eligible for. Here are the key reasons your debt-to-income ratio is important.

It determines your eligibility for new loans

A high debt-to-income ratio limits your eligibility for new loans and credit facilities. Lenders will consider your repayment capacity lowered because your current debt levels are high. On the other hand, if your DTI ratio is lower, you will find it easier to avail a new loan or apply for a new credit card.

It plays a key role in the credit limits available to you

Even if you are eligible for a new loan or a credit facility, the DTI ratio will determine the maximum amount you can borrow. A high DTI ratio will result in lower credit limits, because lenders may not be sure if your current income may be sufficient to repay higher amounts of debts.

It affects your financial goals

Many major financial goals like building your dream home, buying a new car or paying for your children’s education abroad may require external financing. Since your DTI ratio influences your eligibility for credit and the amount of loan that you can borrow, it eventually affects your ability to achieve your financial goals as planned.

Strategies to Improve Your DTI Ratio

Improving your DTI ratio is not just about reducing debt; it's about creating a sustainable financial ecosystem. Now that you know what debt-to-income ratio is, let's find out some ways you can improve it.

Pay Down High-Interest Debts: Focus on debts with the highest interest rates, like credit card dues. Reducing these debts first can decrease your overall monthly obligations.
Avoid Taking on New Debt: While working on improving your DTI, refrain from taking on additional debt that can increase your monthly payments.
Increase Your Income: While easier said than done, boosting your income can effectively lower your DTI ratio. Consider side gigs, part-time jobs, or seeking raises at work.
Restructure Existing Debts: Restructuring your debts can sometimes lead to more favourable terms, such as lower Personal Loan Interest Rates or extended loan tenures. This can result in smaller monthly payments, thereby improving your DTI ratio.
Budget and Expense Management: Implementing a strict budget and cutting down on non-essential expenses can free up more of your income to address debts. Effective budgeting not only helps in debt reduction but also prevents the accumulation of additional liabilities.
Consolidate Multiple Debts: Consider a debt consolidation loan if you're juggling several high-interest loans. This can combine all your existing debts into one loan with a potentially lower interest rate, simplifying your payments and reducing your monthly debt obligations.
Regular Monitoring and Review: Keep a close eye on your financial situation. Regular reviews can help you stay on track with your debt reduction goals and make timely adjustments to your strategies for improving your DTI ratio.

Managing Personal Loans to Maintain a Healthy DTI Ratio

Personal Loans, when used judiciously, can help maintain or even improve your DTI ratio.

Debt Consolidation: Use a Personal Loan from Kotak to consolidate high-interest debts into one loan with a lower interest rate, reducing your monthly payments and improving your DTI ratio.
Personal Loan Fees & Charges: Always take note of any additional costs associated with Personal Loans, as these can affect your DTI ratio.

By understanding how to calculate and improve your DTI ratio, you can better position yourself for financial success and gain access to the credit you need.