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Debt-to-Income Ratio (DTI): A Complete Guide

debt to income ratio

Imagine getting that latest phone or building your dream home. It sounds exciting, right? But will your loan be approved? That depends on several factors with one of the most important being your Debt-to-Income-Ratio (DTI). Lenders use your DTI, alongside your credit history and other criteria, to assess your ability to repay the loan.

Understanding the term: Debt-to-Income Ratio (DTI)

In simple terms, the debt-to-income ratio DTI Ratio is calculated by dividing all your monthly debt payments by your gross monthly income. The ratio shows the percentage of your income allocated towards debt payments. Key takeaway? The lower your DTI Ratio, the better your financial standing looks to lenders.

Calculating the DTI:

Calculating your Debt-to-Income (DTI) Ratio is straightforward. Just use this simple formula

Let’s break down how to calculate your Debt-to-Income (DTI) Ratio with an example. If your monthly debt payments total ₹2,000 and your monthly income is ₹10,000, your DTI Ratio would be 2,000/10,000, which equals 20%. This means that 20% of your gross monthly income is used to pay off debt.

To ensure your DTI Ratio is accurate, include all your debts and income sources.

Debt payments can include:

  • House rent
  • Credit card payments
  • Personal or student loans
  • Auto loans

For monthly income, be sure to count:

  • Salary
  • Bonuses
  • Freelance income, if any
  • Rental property income

However, your monthly debt payment does NOT include:

  • Groceries
  • Fuel
  • Phone bills
  • Health insurance
  • Auto insurance
  • Entertainment

By accurately including all relevant debts and income, you can get a clear picture of your financial health and improve your chances of loan approval.

Debt-to-Income (DTI) Ratio: a general breakdown

Let's take a look at what the DTI Ratio reveals about your debt situation:

DTI ≤ 36% = debt likely manageable DTI ~ 36% - 42% = opportunity to improve
DTI ~ 43% - 49% = slippery slope DTI ≥ 50% = TAKE ACTION

Why Debt-to-Income Ratio matters:

Loan Approval:

  • A High DTI Ratio suggests you might struggle to repay a new loan in addition to your existing debts, making lenders hesitant to approve your application and may see you as a high-risk borrower.
  • Inversely, the Low DTI Ratio demonstrates good financial management, making it easier for you to secure loans at favorable terms and interest rates.

Financial Health:

  • A High DTI Ratio Indicates that a large portion of your income goes towards debt payments, reducing your financial flexibility.
  • A Low DTI Ratio: Shows a healthy balance between income and debt, highlighting strong financial habits and stability.

Does my DTI ratio affect my Credit Score?

Your Debt-to-Income (DTI) ratio does not directly affect your credit score. However, a high DTI Ratio can suggest high credit utilization - which might impact your Credit Score. Both DTI and Credit Score are crucial for maintaining good financial health and are key factors that lenders evaluate when deciding on loan approvals. Hence, managing both is essential.

How to lower your DTI Ratio?

Reducing your Debt-to-income (DTI) ratio enhances your chances of securing credit in the future. Here are some ways that you can opt for:

  • Increase your income: Explore additional income streams, such as starting a side hustle or selling unused items, to boost your earnings
  • Pay your credit card balance: Clearing credit card balances reduces monthly payments and lowers your DTI Ratio.
  • Prioritize paying off any pre-existing loans like student loans, etc.
  • Opt for Debt consolidation program . Debt Relief Platforms like Freed help you gain a better understanding of your finances and lower your DTI Ratio.
  • Refrain from taking on new loans or credit, which helps keep your DTI Ratio low.

Managing your finances and reducing your DTI Ratio may seem challenging, but it’s achievable with informed strategies. Discover how platforms like Freed can assist you in managing high DTI and debts effectively at www.freed.care. Start your journey with FREED towards a debt-free life today!

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