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What Is the Debt-To-Income Ratio and How to Get It Right?

  • Highlights

  • It is a ratio of monthly debt repayments to monthly gross income

  • A lower DTI ratio is considered better while availing loan

  • A higher gross monthly income will bring DTI down

  • Keep a monthly record of DTI ratio

Debt-to-Income Ratio (DTI) is a measure of a borrower’s debt repayment capacity, as per his or her gross monthly income. In simple terms, DTI is the gross of all monthly debt payments divided by the gross monthly income, calculated as a percentage. It is a tool that financial institutions and lenders (including mortgage lenders) use to anticipate a borrower’s ability to make monthly payments towards the debt and in turn repay the total amount.

Breaking down DTI

A borrower’s gross monthly income is the total he or she has earned, before taxes and other charges are deducted. For example, let’s say that you pay an EMI of Rs.25,000 towards a home loan and Rs.15,000 towards a car loan. So, your consolidated EMI toward both your loans add up to Rs.40,000. If your gross monthly income is Rs.80,000, the debt-to-income ratio would be 50% (Rs.40,000 divided by Rs.80,000 expressed in percentage). A high debt-to-income ratio shows an inability to pay new EMIs.

Now, there are two ways in which you can reduce your DTI ratio. The first is by reducing your EMIs, while your gross income remains the same. In the above example, if your EMIs come down from Rs.40,000 to Rs.35,000, the DTI will be a revised 43.75%. The second way is by increasing your gross monthly income, while the EMIs remain the same. Again citing the above example, if your gross monthly income increases from Rs.80,000 to Rs.90,000 while EMIs remain unchanged, the revised DTI ratio will be 44.44%. Choose the way better suited to your situation.

Why is a DTI ratio important?

Your debt-to-income ratio is one of the factors that affect your credit score, and is important when you wish to avail a loan. A low DTI ratio shows your creditworthiness, and improves your chances of getting a loan approved and sanctioned.

What should you do to better the ratio?

- You can increase your EMIs toward a loan that you have availed. Though this will temporarily increase your DTI ratio (considering your income doesn’t change), it will, in the long run, bring down your total debt considerably. This, in turn, will reflect well on your DTI ratio.
- Do not acquire more debt
- Postpone a few large purchases if you can. This will give you more time to save and help you make a larger lump sum payment in time.
- Don’t forget to keep a track of the debt-to-income ratio every month. This will make it easier for you to notice deviations, if any, and take corrective measures.

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