The debt to income ratio is a threshold to measure your creditworthiness. Let us explain to you whatever you need to know about debt to income or DTI ratio.
What is the Meaning of the Debt to Income Ratio?
As the term suggests, the debt to income ratio meaning is the proportion of your total monthly income towards your monthly debt repayment. The lending institution calculates this to assess your repayment capability while providing you with any loan. It is necessary to maintain a healthy DTI ratio, especially for unsecured loans such as personal loans.
Why is DTI Ratio Crucial for Taking Personal Loan?
If your debt to income ratio is low, it shows your good financial position. And that is a positive point in your favour when applying for a personal loan. These loans are generally unsecured. Banks or lending institutions don’t have any collateral with them. Thus they rely heavily on your credit score and DTI ratio.
It indirectly affects your credit score also. If your debts are high, you might default on any of your repayments. This default shows badly on your credit score.
Is High Debt to Income Ratio Bad?
A reasonable DTI ratio would be less than 50% of your gross monthly income. Anything more than that means you are surrounded by debts or in a debt trap. This is not good for your future. Thus it becomes necessary to maintain a low debt to income ratio.
How Can High Debt to Income Ratio Adversely Affect Your Financial Planning?
High debts disrupt your finances in more ways than you can think of! The financial institution and banks will doubt your creditworthiness. You will face problems in your loan getting approved. Not only personal loans but car loan or home loan will also become challenging to get.
Not to forget, high debts indirectly affect your credit scores as well. If you at all got loan with low credit scores, it will be at a high interest rate. Apart from the financial factor, a high DTI ratio affects your mental health as well. It adds anxiety and stress, so you are better off few things rather than taking heavy debts.
How to Calculate Debt to Income Ratio?
It is pretty easy to calculate your DTI ratio. Follow these steps:-
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Step 1 – Add up all your monthly EMIs and other debt payments like loans mortgage. -
Step 2 – Calculate your monthly income before tax. Add any incentives or extra income from part-time jobs or rent etc. -
Step 3 – Divide your total debt by your total income, both monthly. -
Step 4 – The result will be a figure in decimal. Multiply it by 100 to derive your DTI percentage. The lesser your debt percentage, the better for your mental peace and financial planning.
What to do If Your Debt to Income Ratio is on a Higher Side?
You don’t need to panic if you are on the wrong track. You can reduce your DTI ratio gradually by altering your spending habits and lifestyle. First of all, stop taking any loans or credit cards. Make arrangements to pay more debt per month. Increasing the monthly payment will take you out of debt quickly. Don’t purchase any expensive items until you are out of your current debt. That costly phone, camera, or speakers can wait.
Spend on things which you need like an affordable vehicle or laptop. Keep reviewing your debt to income ratio every month. You might control your debts initially but might forget later. This monthly review will keep you in check.
