Many feel that the DTI aka Debt to Income Ratio is not that important a parameter when it comes to calculating the credit score. However, DTI still plays a crucial role in determining your credit health and would definitely be one of the major components considered in the credit application in case you apply for a mortgage or loan.
DTI and its Impact on Credit Health
The Debt to Income Ratio would help a lender evaluate the exact amount of additional debt an individual can handle. It would also point out the credit risk posed by the individual availing the loan.
DTI is calculated by dividing an individual’s monthly income with his/her monthly debt payments (the total figure) in terms of student loans, housing loans, auto loans, credit card payments and other regular debt obligations.
Since the credit report usually does not contain a column for monthly income, the individual availing the loan/mortgage would need to provide either an official documentation or a self-reported estimate of his/her monthly income.
An eligible DTI would increase the individual’s chances of getting credit. Lenders would usually go through an individual’s DTI in detail before offering him/her credit as it would act as an indicator of the individual’s ability to repay the loan. The credit risk derived from the DTI would also allow lenders to set interest rates for the credit accordingly.
A low DTI ratio would indicate that an individual can easily repay his/her debts owing to available income. A high DTI ratio on the other hand, would indicate that the individual already has too many debt obligations and would not be able to handle the burden of another debt.
Ideal DTI Ratio
The normal DTI ratio that lenders usually look for is a figure less than 36%. Therefore, individuals with DTI ratios of 36% or higher stand higher chances of being denied credit, or paying higher interest rates even if they do qualify for it.
A simple calculation would help one understand how his/her ideal DTI situation needs to look like if he/she wants to avail a loan or mortgage. For instance; consider the gross monthly income to be about INR 4000.
By multiplying it with the acceptable 36% DTI ratio would then give the individual the amount he/she would need to spend on monthly debt payments. In this case,
You get Rs. 1440 as the amount you should pay on monthly debt payments on a monthly income of Rs. 4,000 which would be at the rate of (x 0.36) DTI.
Measures to Lower DTI
Individuals with higher DTI ratios would need to lower the same if they want to avail a loan/mortgage with minimum hassles. This can be done by either lowering the total monthly debt payments or increasing the monthly income.
You can do this by lowering your credit card usage, avoid extravagant expenses and decrease the amount of loans or simply increase your monthly income by any means. The idea is to strike a balance in order to maintain a lower Debt-To-Income Ratio.