If you are planning to apply for a personal loan, you have probably come across the term debt-to-income ratio. But what is a debt to income ratio and how does it affect your personal loan application? Let’s clear the air!
What Does Debt To Income Ratio Mean?
Debt to income ratio refers to the total amount of debt you have with respect to your gross monthly salary. Here, gross monthly salary refers to the amount you are entitled to before taxes and additional deductions.
But what exactly qualifies as debt? In the simplest terms, your debt includes the amount you pay every month for your installments and credit card bills. This doesn’t include your fixed monthly expenses like utility bills.
Why Do Lenders Use Debt to Income Ratio?
Debt to Income ratio is used by lending institutions when you apply for an instant personal loan with them. They use this ratio for assessing your abilities in repaying the loan. Regardless of your ticket size, your lender would want to ensure that you are indeed capable of paying off the fixed installment every month.
If your debt to income ratio is high, it indicates that you are not too good at managing money. This reduces your chances of approval. Alternatively, if you have a low debt to income ratio, lenders tend to rely on your money management skills and your loan is approved faster.
Almost all consumer lending institutions use the debt to income ratio before sanctioning a loan. This is also used by loan officers and underwriting professionals. Your debt to income ratio, however, isn’t used by credit card issuers while they issue a new credit card.
How Is Debt to Income Ratio Calculated?
Your debt to income ratio is calculated by dividing your monthly debt by your gross monthly salary. So, if you have a fixed debt of Rs 10,000 every month and your gross income is Rs 40,000, divide 10,000 by 40,000. The final number, 0.25 or 25%, is also your debt to income ratio. A debt to income ratio of 25% is deemed good. However, if it crosses 30% or higher, you need to pay more attention to your financial habits.
How to Calculate My Debt to Income Ratio?
While you can always use our formula for calculating your debt to income ratio, an online debt to income ratio calculator is of equal help. The debts that should be included in your calculation are your credit card payments, home loans, personal loans, car loans, education loans, alimony, and any other recurring monthly payment.
What Is a Good Debt to Income Ratio?
As we previously mentioned, any debt to income ratio ranging from 25% to 30% is deemed good. So, your number is higher, start cutting down your monthly expenses. Avoid luxurious outing, take public transport, try home-cooked dinners instead of fancy meals, and trim all the unnecessary spending.
Once you embrace these positive financial habits, you’re a step closer to getting the best personal loan offer.