Debt to Income Ratio is Significant. Have You Checked It?

28 Jan 2021

On time salary, high credit score, and good repayment history - are these enough to determine your eligibility criteria? Wait… the title suggests you need good debt to income ratio. Huge numbers of applications are rejected on the grounds of high debt payout. Here, we will tell you why you need less debt for making a winning loan application.

Everyone would tell you that keeping your debt manageable is one of the prerequisites for sound financial health. But is there any mechanism by which you can assess when is your debt going out of manageable proportions? Fortunately, there is a way out to estimate whether you are currently having too much of debt, well before you actually realize that you are not in a position to afford any more monthly payments and your all-important credit score starts diminishing. It is your Debt To Income Ratio (DTI) that provides you with this critical piece of information and allows you to evaluate how at peace you are with the current position of your debt.

When you go through the process of applying for a personal loan or a mortgage, very often you find out the term  Debt To Income Ratio, used extensively by your lender. The lenders calculate your DTI to assess your financial habits as it gives them an accurate measure of how much debt you can usually maintain, in comparison to your income. Therefore, it is highly imperative that, as a borrower, you understand your DTI properly, know how to compute and to improve it.

When you apply for credit, lenders use your DTI to determine what percent of your gross monthly income goes towards paying debts, such as rent, mortgage, credit cards, or other debts. This number approves your eligibility and allows how much money you can borrow. In general, if 36% or more of your income is being spent clearing debts, your borrowing capacity may become limited or expensive irrespective of all other indicators of the eligibility criteria.

However, in compliance with the recent changes to federal laws, mortgage lenders are forbidden from approving loans for potential buyers whose entire monthly debt exceeds 43% of their monthly gross income. For example, if someone, whose income is $125,000 a year and has a $450-a-month car payment, is seeking a $626,000 loan with a 4.5 percent interest rate to buy an $800,000 house, he or she would fall within the limit. However, if he or she has also a $100 education loan EMI, the debt-to-income ratio would go above the restriction.

You can calculate your own debt-to-income ratio and understand what it means to lenders. 

How to calculate your debt-to-income ratio? 

You can calculate your DTI ration by following below steps:

Step 1:

Add up your monthly bills which may include:

  • Monthly house rent

  • Monthly child support payments

  • Education, auto, and other monthly loan payments

  • Credit card monthly payments

  • Other Debts

Expenses like utilities, groceries, gas, electricity, etc. are not included.

Step 2:

Divide that total by your gross monthly income, which is your income before taxes.

Step 3:

Multiply it by 100. Voila, the result is your DTI in the form of a percentage. The lower the DTI, the more eligible you are to apply for credit.

Reducing your revolving debt by a few percentage points or something as small as a $100 more in monthly rent impacts your DTI. The difference between debt to income of 20% and 25% can be thousands of dollars in interest.  

How to improve your debt to income ratio?

We will tell you the good news now. There are ways by which you can improve your debt to income ratio. We will discuss three such ways here-

  1. Reduce your spending

Take a long and hard look at where has your spending gone this month and if possible, adjust this to save enough money next month. For example, if you eat out too often, you may consider ‘living’ more on home foods. If you have a habit of making unnecessary spending, make a concerted effort to put brakes on it and instead, use the money to repay a loan or cover for an outstanding credit card amount.

The secret is that, if you make a careful review of your spending, you will discover many areas where you can save enough money and use the extra cash thus saved to repay your outstanding debt.  As you will discover for sure, saving money in bits and pieces can make a big difference eventually when you accumulate them over a period of time and make good use your savings.

Another way to put some brakes on unnecessary spending is to use the cash more, instead of using credit cards. When you see cash physically in your hands, it becomes that much harder to buy something absolutely unnecessary, which you often tend to do when you use credit cards.

You may also consider getting rid of things you no longer require, but you are keeping them simply because you are emotionally attached to them (for example, old furniture lying in your store). You may consider selling them online/offline and use the money thus obtained to repay one of your debts.

  1. Look for ways to increase your monthly income

Increasing your monthly income can go a long way towards lowering your DTI. As discussed above, if someone earns $2000 a month and pays $1000 to repay his debt, he has a DTI of 50 %. However, if his monthly income gets increased to $3000, his DTI is reduced to 33 %.

This is the reason why you should look for ways to increase your monthly salary/income. Show some outstanding achievement at work or take some extra responsibilities and ask your employer for a pay hike. If your employer is not willing to reward your hard work/achievement, start looking for alternative options.

You can also look for other avenues to increase your monthly income. A part-time job or an after-office, ‘work-from-home’ option can help you in this regard. 

  1. Consolidate your debt

Consolidating your debt is an excellent method to reduce your monthly repayments. Let us suppose you have six credit cards, each having a minimum payment of $50 and amounting to a total minimum payment of $300. Now, if you somehow consolidate all your debt into one single payment, your monthly minimum payment would amount to only $150 and thus, you will be able to save $ 150 every month.

The best way to consolidate debt is to repay the outstanding balance quicker by applying additional funds. If you have multiple credit cards, it is a good idea to pay off the card with the highest rate of interest first make at least 2 minimum payments every month.  

We, at Afinoz, are dedicated to helping you avail loans at competitive Annual Percentage Rate (APR) from best lenders in the market. Fill out the blog form, and we will contact you.