Relation between Debt-to-income ratio & Personal Loan

Date: 23rd September 2024 | Read time: 4.5 Minutes

While processing an application for a personal loan, a lender assesses an applicant's debt-to-income ratio very keenly. It reflects the percentage of your monthly income that goes into paying off debts. This gives the lender complete clarity on whether the applicant can repay his new loan on time.

The debt-to-income ratio is the percentage that portrays how much of your gross monthly income is spent on paying debts such as credit cards, loans, and mortgages. The lower the DTI ratio, the more of your income is free to be devoted to new financial obligations. This increases your chances of qualifying for a personal loan. A high DTI ratio reflects debt stress, so you will appear to be a greater credit risk to lenders.

Calculating DTI is simple: divide your total monthly debt repayments by gross month-on-month income, and multiply by 100.

For example, if you pay ₹40,000 every month toward debts, earning ₹1,00,000 every month, then this is how your DTI ratio would look:

(₹40,000 ÷ ₹1,00,000) × 100 = 40%

This implies that 40% of your income goes for paying debts back.

Basically, for sanctioning personal loans, all lenders prefer a DTI ratio less than 40%. Above that, it's danger territory that means you are not capable of handling more debtors, and it will be tough to approve the loan. A low DTI ratio keeps you in a better position to obtain a loan on good interest rates, while a high one may make it costly or even get disapproved.

• 30%: Excellent. Most likely to get approval.
• 30%–40%: Good. Considered safe by most lenders.
• 40%–50%: Bad. You may get loans, but at higher rates.
• Above 50%: Bad. Most likely, this will lead to rejections and unfavorable terms.

[Also Read: How a Personal Loan Can Help You Achieve Your Financial Goals?]

A good DTI ratio, in essence, informs the lender that you're capable of servicing your debts responsibly. The DTI ratio denotes the ability of a borrower to repay a loan without over-burdening his/her finances. DTI ratio plays an important part in defining your interest rate on personal loan and terms of the loan.

If you want to improve your DTI ratio, you may choose to repay some of the existing loans before applying for a personal loan. Reduced credit card balances, smaller loans, and refinancing of existing loans at lower rates will bring down the DTI ratio and enhance the chance of loan approval.