Understanding Debt-to-Income (DTI) Ratio & How to Calculate Your DTI

Debt-to-income ratio serves as an efficient financial metric that helps individuals to relate their total monthly debt to their gross income. This metric takes into account the income generated from all sources before taxes have been deducted. Under normal circumstances, DTI helps financial institutions to understand whether an individual’s financial standing is stable or worrisome. To understand DTI better, individuals should become familiar with the concept and how it may impact them.

Significance of Debt-to-Income-Ratio

Most financial institutions use DTI to measure a loan applicant’s credit risk. Typically, a high debt-to-income ratio indicates that an individual is more likely to default on an availed loan. Under any given situation, a DTI of 40% or above it reflects a financial crunch or instability. This discourages financial institutions from approving a loan application. Even if the loan plea gets approved, it is more likely that applicants will have to pay a higher rate of interest on the availed loan amount. 

On the other hand, a DTI of 20% or below is considered to be a good DTI ratio and serves as an indicator of robust financial standing.  It projects a positive picture of applicants’ ability to repay debt and thus encourages lenders to approve their personal loan applications promptly. 

How to calculate DTI ratio?

Individuals can compute their DTI by adding all their monthly debt payments and dividing the aggregate value by their monthly income before tax is deducted. Its formula is expressed as – 

Debt-to-income-ratio = Monthly debt payment/Gross monthly income

Notably, the preferred range of DTI ratio may vary from one financial institution to another. Regardless, individuals should always try to maintain a lower ratio by following simple strategies to manage their debt.

Tips to improve DTI ratio

Individuals can enhance their debt to income ratio by following these simple but useful tips –

• Increasing EMI

Increasing the existing loan EMIs can prove useful in lowering one’s DTI ratio. Although initially, it will increase the ratio, paying a higher EMI will bring the ratio down successfully. With an increase in EMI, the tenor will shorten, and in turn, it will help borrowers to pay off their debts quicker. 

• Refraining from availing credit

While trying to lower the existing DTI ratio, individuals must be cautious against availing additional credit. Accumulating debt will only make it harder to achieve the good DTI ratio and in turn, will hamper individuals’ CIBIL score.  

• Opt for a loan balance transfer

Another potent strategy to lower the DTI ratio is by facilitating easy repayment. One of the best ways to pay off loans is to avail a loan balance transfer and transfer the existing loan to a new financial institution. Regardless, to make the most of this particular strategy, borrowers should pick a lender who extends a lower rate of interest when compared to their current lender. 

However, borrowers should refrain from a loan balance transfer if their loan tenor is towards the end. They should also factor in the associated charges to undertake such a transfer so that they do not end up increasing their existing debt burden. 

• Consolidate your debts

Borrowers also have the option to opt for debt consolidation to lower the debt burden and improve the ratio. However, such a strategy will prove beneficial only if borrowers qualify for a lower rate of interest and better terms of repayment. At the same time, they should factor in the fees and charges on personal loan for debt consolidation. They should look for leading financial institutions like Bajaj Finserv who offer a high loan amount at an affordable rate of interest to pay off consolidated debt. 

The NBFC also provides pre-approved offers to customers to make the entire process hassle-free. Generally, such lucrative benefits are offered on financial products like personal loans and business loans. You can check your pre-approved offer online by just entering your name and contact number. 

While at it, borrowers should consider figuring out how to use a personal loan for debt consolidation to manage it successfully.  

• Track your DTI

Borrowers must also be mindful enough to track their debt-to-income ratio every month. Doing so, they will be better informed about their financial standing and will be able to take necessary reformative measures at the earliest. Maintaining this particular habit for the longest will help manage debt and income more effectively.

Besides these, individuals should also look for ways to increase their monthly income or find ways to generate extra earnings. It will help to improve the debt to income ratio and will directly enhance their creditworthiness.