What is Debt To Income (DTI) Ratio

For maintaining a sound financial health, it is important to keep your debt at a manageable level. But, how do you realize when your debt begins to spiral out of control? Luckily, there’s a way to determine whether you have too much debt without waiting until you realize you can’t make your monthly payments or your credit score starts to decline. All you need to do is to check the DTI ratio using the debt to income ratio formula. So, let’s check out what debt to income ratio exactly is.

What is Debt to Income Ratio Meaning?

Debt to Income Ratio, or simply DTI ratio, is a financial metric that compares your monthly debt payments to your monthly income. DTI is frequently used by lenders to evaluate an individual’s creditworthiness and decide whether they are eligible for a loan. In India, DTI ratio which is less than 20% is considered a good debt to income ratio.

An individual is more appealing to the lenders if their debt-to-income ratio is lower than monthly income because it shows that they have a healthy balance between the two. DTI ratio is a crucial indicator of your debt management skills and is expressed as a percentage. It shows how stable your finances are right now and may affect your future loan eligibility. 

How to Calculate Debt to Income Ratio?

Debt to income ratio is calculated using a simple formula mentioned below:

Debt to Income Ratio Formula: Debt to Income Ratio = (Monthly Debt Payments ÷ Gross monthly income) x 100

The formula has been explained in the points below:

• Find out Monthly Debt: To know about your monthly debt, sum up your monthly payments, like EMIs for existing loans, credit card payments and other recurring payments of debts. 
• Calculate your Gross Monthly Income: It refers to your monthly income before deductions and taxes.
• Perform Debt to Ratio Calculation: You need to divide your total monthly debt by your monthly gross income and then multiply the result by 100 to get a percentage. The percentage will be your debt to income ratio.

Example of DTI Ratio

Let’s understand the debt to income ratio with the help of an example. Suppose, your gross monthly income is Rs. 1,00,000. This month, to settle your debts/liabilities, you pay the below-mentioned sums.

• EMI for Home Loan = Rs. 30,000
• Credit card Dues = Rs. 14,000 
• EMI for Car Loan = Rs. 8,000

In this case, the total monthly debt payments will be Rs. 52,000. The DTI ratio will be calculated as follows:

DTI Ratio = (Rs. 52,000 ÷ Rs. 1,00,000) x 100 = 52%.

Why is the Debt-to-Income Ratio Important?

Debt to income ratio helps you to make out where you stand financially. It helps to determine the credit facilities you are eligible for. The importance of debt to income ratio India can be understood through the following points:

• A debt to income ratio determines whether you are eligible for a new loan or not. If your DTI ratio is high, your eligibility for new loans and credit facilities will be limited. Since your current debt levels will be high, your repayment capacity will be considered as lowered for the lenders. However, in case of a lower DTI ratio, availing a new loan or applying for a credit card will be easier.
• DTI has a major impact on your credit limitations. The maximum amount you can borrow will be determined by the DTI ratio, even if you are qualified for a new loan or credit facility. A high DTI ratio will result in reduced credit limits because lenders might be unsure if your present income would be enough to pay off larger obligations.
• External funding may be necessary for many significant financial objectives, such as building your ideal home, purchasing a new vehicle, or funding your children’s education overseas. Your DTI ratio ultimately impacts your capacity to meet your financial objectives since it determines your credit eligibility and the maximum loan amount you are able to obtain. 

Conclusion

DTI is a financial metric that compares your monthly debt payments to your monthly gross income. To check whether your debt is too high compared to income, you can use the debt to income ratio formula. If you want to obtain a loan easily and have sound financial health, keep your DTI ratio low. If this ratio is too high, lenders might think you cannot pay big loans.