Debt-To-Income Ratio: How It Impacts Loan Approval, And Ways To Improve It

While applying for a loan, lenders check many factors to evaluate the eligibility. One of the significant factors they consider is repayment capability and financial stability of the borrower. The debt-to-income (DTI) ratio is one such factor lenders rely on to determine the repayment capability of a borrower, and thus, it has a significant impact on approval of your loan application.

Thus, considering your DTI ratio can help your loan approval chances, and at favourable rates of interest.

What Is DTI Ratio?

DTI ratio indicates proportion of the borrower’s income that goes towards repaying debts. The lender uses it to determine whether you can afford more debt before they approve your loan. A lower DTI ratio enhances the likelihood of getting a loan approved and at favourable rates of interest.

How To Calculate DTI Ratio?

Here’s how you can calculate your DTI ratio.

Step 1: Calculate the total monthly payments on all of your debts, including your equated monthly instalments (EMIs) on credit cards, auto loan, home loan and other fixed debt commitments

Step 2: Determine your entire monthly income before taxes, taking into account any profits from a job, rental property, or other sources

Step 3: Use the formula: DTI Ratio = (Total monthly debt payments ÷ Monthly income) × 100

Step 4: Check the results. A lower DTI ratio indicates a higher likelihood of loan approval, while a higher ratio can suggest financial difficulty.

What Is The Ideal DTI Ratio?

DTI ratio, which measures your capacity to repay debt, is a significant factor in deciding whether you will be granted a loan.

Says Gaurav Goel, Founder, Lamoksh Investments and a Securities and Exchange Board of India-registered investment advisor (Sebi-RIA): “The ideal DTI ratio for most borrowers is 30-40 per cent. This range implies a healthy balance between existing debt and income, increasing your chances of getting new loans or loans at favourable conditions.”

He adds: “A DTI ratio above 50 per cent is considered risky, signalling the possibility of financial strain and an increased likelihood of default. On the other hand, a ratio under 20 per cent is considered excellent and can increase your chances of loan approval, as well as potentially lower your interest rates.”

What To Do If Your DTI is Too High for Loan Approval?

Managing your current debt is crucial if your DTI is high. So, before applying for a fresh loan, lowering your DTI can have a big impact on chances of getting your loan application approved.

Says Goel: “Borrowers with a high DTI should refrain from taking on more debt. Paying off high-cost debts, such as credit card loans, can help lower the ratio. It’s also advisable to engage with existing lenders to reduce interest rates, helping to improve the DTI without the need for refinancing.”