Debt-to-income ratio and personal loans: Some important aspects you must be aware of

Whether you want to fund a home renovation project or take a luxury vacation, personal loans have become an easy and convenient way to meet monetary requirements. As a personal loan is usually unsecured in nature, lenders use various parameters to determine loan eligibility. One such crucial parameter is the 'debt-to-income ratio (DTI)'.

The Debt-to-income ratio helps banks and NBFCs understand your creditworthiness. When the DTI is in the ideal range, it indicates good financial health, reducing the risk for lenders. 

Let’s check out the different aspects of the debt-to-income ratio and its applications.

What is debt-to-income ratio?
 

Debt-to-income ratio (DTI) is a financial metric used by banks and NBFCs. The purpose of DTI is to determine an applicant’s ability to manage debt repayments. To calculate DTI, you must divide the total Equated Monthly Instalments (EMIs) by the gross monthly income. The resulting percentage is your debt-to-income ratio.

For example, let's say your total monthly debt is Rs 50,000 and your gross monthly income is Rs 1,00,000.

DTI Ratio = (50,000 / 1,00,000) x 100 = 50%

Also read - Tips to avail of a personal loan despite a low credit score

Importance of debt-to-income-ratio in personal finance
 

Debt-to-income ratio is a crucial financial metric pertaining to the reasons mentioned below -

• Financial health - Debt-to-income ratio serves as an indicator of the applicant’s ability to manage EMIs.
• Eligibility - Debt-to-income ratio helps lenders determine personal loan eligibility. A higher debt-to-income ratio indicates greater debt burden and strain on finances. Whereas lower DTI lowers the risk of default.
• Financial planning - Debt-to-income ratio helps you make informed decisions related to your finances. You are in a better position to ensure timely EMI payments.

How DTI impacts personal loans?
 

Debt-to-income ratio plays a crucial role in the personal loan approval process. Let’s have a look into some key aspects of DTI in personal loans -

• Role of debt-to-income-ratio in the loan approval process - Lenders use DTI to understand the borrowers’ ability to repay the loan. Borrowers can use DTI to determine their loan approval chances and for subsequent financial planning.
• Lenders' perspective on DTI - Debt-to-income ratio is an extremely crucial parameter from the lenders’ perspective. Lenders prefer applicants with a DTI lower than 40%. This ensures that there are higher chances of timely EMI payments.
• Borrowers' perspective on DTI - You must strive for a debt-to-income-ratio of less than 40%. This will improve the chances of loan approval with lower interest rates, thereby reducing your financial burden.
• Impact of DTI on loan interest rates and loan terms - Debt-to-income ratio directly indicates the repayment ability of borrowers. Therefore, lenders offer lower interest rates and better terms for borrowers with a lower DTI.​​​

Strategies for improving DTI for loan eligibility
 

If you plan on applying for a personal loan, then it is essential to work towards improving your DTI. Here are some strategies you can employ for this purpose -

• Reduce debt - You must try to repay your existing debt exposure to improve your debt-to-income ratio. This will include repayment of credit card dues and other personal loans. As a result, the denominator in the DTI formula will decrease, leading to a lower debt-to-income ratio.
• Alternate income sources - You can look for some alternatives to boost your monthly income. For example, you can generate rental income by leasing out additional rooms in your house. Alternatively, you can offer online or offline tuition to kids during weekends. With a higher monthly income, you will have more funds to repay the EMIs.
• Avoid new loans - Do not apply for new credit cards or go for consumer loans to finance your purchases. Try to manage your expenses through budgeting to reduce debt exposure. This approach will help maintain your debts and keep the debt-to-income ratio under control.

Factors to consider before applying for personal loans with high DTI
 

Here are some crucial factors you must consider before applying for personal loans with high debt-to-income-ratio - 

• Disposable income - You must first prioritise your existing EMIs and essential expenses. Only take a personal loan with a high DTI if your financial situation permits. 
• Interest rates - Lenders tend to charge higher interest rates for personal loans with high DTI. Higher interest rates mean higher EMIs; therefore, you must assess the overall cost of borrowing before deciding. 
• Other options - You may consider balance transfer or debt consolidation for your existing loans. Other lenders may offer you better terms, lowering your debt-to-income ratio without any new debt.

Also read - Debt consolidation for personal loans: What you need to know

To conclude
 

IDFC FIRST Bank offers you high-value personal loans with low-interest rates and favourable terms. With a seamless application and disbursal process, IDFC FIRST Bank Personal Loan caters to all your financial needs. With IDFC FIRST Bank Personal Loan balance transfer options, you can effectively lower your debt-to-income ratio and enjoy complete financial freedom.

Apply for an IDFC FIRST Bank Personal Loan online.

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.