When applying for a personal loan, lenders use various criteria to assess your creditworthiness and determine whether you qualify for the loan and at what interest rate. One of the factors lenders mostly consider is your debt-to-income ratio (DTI). So, let’s learn more about this.
What is debt-to-income ratio (DTI)?
The debt-to-income ratio measures your monthly debt payments compared to your monthly income. To calculate your DTI, add all your monthly debt payments (such as credit card payments, mortgage payments, car loan payments, etc.) and divide the total by your gross monthly income (your income before taxes and other deductions). The result is your DTI expressed as a percentage.
For example, if your monthly debt payments are Rs 10,000 and your gross monthly income is Rs 50,000, your DTI is 20% (Rs 10,000 ÷ Rs 50,000 = 0.2 or 20%).
How does DTI affect your personal loan calculator results?
- Loan amount: A high DTI may limit the amount of money you can borrow. Lenders may be hesitant to lend a large amount of money if your DTI is too high, as it may indicate difficulty managing your debt.
- Interest rate: A high DTI may also result in a higher interest rate on your loan. Lenders may charge a high interest rate to compensate for the additional risk by lending to someone with a high DTI.
- Loan eligibility: Lenders use your DTI ratio to determine your loan eligibility. If your DTI ratio is high, lenders may consider you a risky borrower, deny your loan application, or offer you a higher interest rate. Therefore, keeping your DTI ratio low is essential to increase your chances of getting approved for a personal loan.
How to improve your debt-to-income ratio?
- Pay off debts: The most effective way to lower your DTI ratio is to pay off your debts. You can start by paying off high-interest debts such as credit cards and personal loans. By reducing your debt, you can free up more disposable income and improve your DTI ratio.
- Increase your income: Another way to improve your DTI ratio is to increase your income. You can do this by taking on a side job, freelancing, or starting a small business. Earning more money can lower your DTI ratio and increase your chances of getting an approval for a personal loan.
- Lower your expenses: You can also improve your DTI ratio by lowering your monthly expenses. You can start by creating a budget and tracking your spending. By cutting back on unnecessary expenses, you can free up money to pay off your debts and improve your DTI ratio.
- Consolidate your debts: Debt consolidation is another option to improve your DTI ratio. You can consolidate your debts into a single loan with a lower interest rate and longer repayment term. Doing so can lower your monthly debt payments and improve your DTI ratio.
Your DTI ratio is critical in determining your personal loan eligibility and interest rate. Therefore, keeping your DTI ratio low is essential by paying off debts, increasing your income, lowering your expenses, and consolidating your debts.