So now you are all set to buy your new home – a flat in Kerala! You are already checking out flats for sale in Kerala and the main thing now is to figure out your financial situation. You decide you need a home loan and approach a bank or any other loan provider. That’s when the term debt-to-income (DTI) ratio becomes all the more important!
So, what is this debt-to-income (DTI) ratio?
DTI ratio is nothing but a personal finance measure that compares an individual’s monthly debt payment to their monthly gross income. The gross income is your pay before taxes and other deductions are taken out. The DTI ratio is the percentage of your gross monthly income that goes to paying your monthly debt payments.
While evaluating the financial fitness of the borrower, banks look at the applicant’s ability to pay off the additional debt burden, besides considering a good credit score. If the applicant has other liabilities like a student loan and an auto loan the credit score is rather low.
Debt-to-income ratio is calculated by dividing the total monthly debt burdens like minimum credit card payments, auto loan, student loan and the like, by net monthly income. The ratio is best calculated on a monthly basis and it helps lenders to gauge how much additional debt can be handled by the applicant.
Debt-To-Income Ratio Formula and Calculation
DTI = Gross Monthly Income / Total of Monthly Debt Payments
What does the DTI Ratio tell you?
A low debt-to-income (DTI) ratio means a good balance between debt and income. If your DTI ratio is 15%, that means that 15% of your monthly gross income goes to debt payments each month. On the other hand, a high DTI ratio may symbolise an individual has too much debt for the amount of income earned each month.
Generally, borrowers with low debt-to-income ratios are likely to manage their monthly debt payments effectively. Banks and financial credit providers prefer to see low DTI ratios before issuing loans as they want to ensure a borrower isn’t overextended.
A DTI ratio of 43% is the highest DTI ratio a borrower can have and still get qualified for a mortgage. Preferably lower than 36%, with no more than 28% of that debt going towards paying off a mortgage or rent payment.
Debt-to-Income Ratio Limitations
The DTI ratio is not the only one financial ratio or metric used in making a credit decision by the lenders. Extending credit to a borrower depends on a borrower’s credit history as well as the credit score. Late payments, delinquencies, balances on credit cards relative to their credit limits, number of open credit accounts, or credit utilization usually weigh down the credit score quite heavily.