A personal loan can be quite helpful because it helps cover extra costs like rent, unexpected medical expenses, wedding decorators, etc. Utilising a loan is simple and fast with an online loan application. But lenders consider your debt-to-income ratio as one of the requirements for approval when you apply for a personal loan. Why do they do it, you wonder? To see how a personal loan’s debt to income ratio relates to it, keep reading.
What is Debt to Income Ratio?
The debt to income ratio (DTI) is a simple way to measure how much of your monthly income goes toward paying your debts. Having a low DTI ratio means you have struck a good balance between your debt and your income. In simpler terms, let us say your DTI ratio is 15% – that means only 15% of your monthly gross income is used to pay off your debts. On the other hand, a high debt-to-income (DTI) ratio indicates that you may have borrowed too much money in relation to your monthly income.
Relation Between Debt-to-Income Ratio and Personal Loan
When you apply for a personal loan, lenders consider your debt-to-income (DTI) ratio to assess if you can handle more debt responsibly. They want to see a low DTI ratio because it shows that you have a good balance between your income and the debt you already have. A lower ratio means you are using a smaller portion of your income to pay off debts each month. This suggests that you have more financial flexibility and can comfortably manage the additional loan payments.
On the contrary, a high DTI ratio raises concerns for lenders. It means a large portion of your income is already going towards debt payments, leaving less room for new loan payments. Lenders may worry that you might struggle to handle even more debt in this situation, and they may hesitate to approve your personal loan application.
Keep in mind that different lenders have different requirements regarding DTI ratios. Some lenders are more flexible while others have stricter limits. Besides this ratio, lenders also consider factors like your credit history, job stability, and overall financial health when deciding whether to approve your loan.
How Does DTI Affect Personal Loans?
Your DTI ratio can have a big impact on your ability to get a Personal Loan and the terms you’re offered by lenders. Here is how it works:
Loan Eligibility:
Lenders look at your DTI ratio when you apply for a loan to make sure you can handle the additional loan payments. If it is too high, lenders might see you as a risky borrower. This could lead to a loan rejection or make it harder to qualify for a Personal Loan.
Loan Amount:
Even if you are approved for a Personal Loan, your DTI ratio affects how much you can borrow. If your ratio is too high, they may offer you a lower loan amount to make sure the monthly payments fit your income.
Interest Rates:
Your DTI ratio also impacts the interest rates lenders offer you. A lower ratio shows that you handle debt well, making you a more attractive borrower. Lenders may give you better interest rates as a result. On the other hand, a higher DTI ratio might lead to higher interest rates as lenders may want to compensate for the risk involved in giving you a loan.
Loan Terms:
If your DTI ratio is higher, they may enforce stricter repayment conditions or ask for more documents to assess your ability to repay the loan. This is done to reduce the perceived risk associated with a higher ratio.
How to Improve Debt-to-Income Ratio
Clear High Balances:
When you have larger debt balances, your DTI ratio tends to be higher. To improve your DTI, start by examining all your debts and identifying the one with the highest balance. By focusing on reducing that particular debt, you not only make progress towards paying it off, but you also gradually lower your DTI ratio with each payment you make.
Consolidate Debt:
Debt consolidation means bringing together all your separate monthly bills into one single payment. You can do this by getting a Personal Loan and using the money to pay off various loans and credit card balances. The great thing about debt consolidation is that your new monthly payment can be lower than what you used to pay for all your individual debts combined. This lower payment helps reduce your debt-to-income ratio.
Reduce Big-Ticket Purchases:
If you are thinking about buying a big-ticket item like a TV or a car, it might be a good idea to hold off until you have improved your DTI ratio. Postponing these large purchases means you will be using less credit. By avoiding the need to rely heavily on credit for the purchase, you can keep your DTI ratio at a lower, more manageable level. This way, you can work towards reducing your debts and improving your financial stability before taking on additional financial commitments.
Calculation of Debt-to-Income Ratio
To determine your debt-to-income ratio, you simply add up all the money you owe each month for debts like loans and credit cards. Then, you divide that total by your gross monthly income, which is the amount you earn before any taxes are taken out. The formula is as follows:
DTI ratio = (Total debt payments per month / Gross monthly income) * 100
For instance, your gross monthly income is Rs.1,20,000, and you have a total monthly debt obligation of Rs.29,000. So, your DTI ratio will be:
(29,000 / 1,20,000) * 100 = 24.16As the DTI ratio is 24.16% and most lenders consider a range of 21% to 35% ideal, you shall be looked upon favourably by lenders when you apply for a Personal Loan.
Instead of manually calculating, you can make use of a DTI calculator, a debt-to-income ratio calculator will help you plan your financial goals better.
Also Read – What is a Debt Trap: Here is How to Avoid It
Conclusion
It is important to keep in mind that different lenders have their own rules about debt-to-income requirements for Personal Loans. It is recommended to compare various lenders to find the one that suits your financial situation best. By maintaining a healthy DTI ratio and being aware of how much you can comfortably borrow, you increase your chances of successfully getting approved for a Personal Loan. This not only helps you secure the funds you need but also sets you up for better financial results in the long run.
Frequently Asked Questions
1.Do Personal Loans count in the debt-to-income ratio?
Yes, your debt-to-income ratio matters when you apply for a Personal Loan. Lenders look at your DTI ratio to see if you can take on additional debt and pay EMIs on time.
2.Is a 50% debt-to-income ratio good?
A 50% DTI ratio would be considered too high for many lenders. This could make loan approvals difficult to get. Even if it gets approved, the borrowed amount may come with high interest rates.
