Debt-to-income ratio: When can lenders reject your loan application? Know how to improve it

New Delhi: When a person applies for a loan, the lender is expected to gauge the applicant's repayment capability based on their credit score. It is a key factor that decides whether a loan application would be accepted or not. However, the debt-to-income ratio could be another crucial aspect that lenders may look into before lending money.

The debt-to-income ratio assesses how much of an individual's monthly income is dedicated to debt repayment. It is the percentage of a person's monthly income that goes towards debt payments.

A credit score helps lenders understand the borrower's financial behaviour and stability based on factors such as a long credit history and a lower card utilisation ratio. Through this, the bank may understand the person's financial management habits.

Meanwhile, the debt-to-income ratio is a real-time window into a person's current financial situation, which gives lenders a look at the borrower's repayment capacity. Knowing how much of a person's monthly income is already committed to debt payments helps the lender understand whether the loan should be approved or not.

How to calculate DTI?

The debt-to-income ratio is calculated by dividing the total monthly debt payment by the total monthly income and multiplying the result by 100.

For example, a person has a monthly income of Rs 50,000 and has to:

• Pay Rs 10,000 towards a home loan
• Pay Rs 3,000 towards a credit card
• Pay Rs 7,000 towards a phone's EMI

This makes the person's total debt obligation Rs 20,000.

The debt-to-income ratio of the person stands at 40 per cent.

A higher DTI indicates that a larger portion of your earnings is dedicated to debt payments, which may negatively impact your loan application.

Though there is no fixed minimum limit that a lender considers for DTI and it may vary across banks, a DTI in the range of 30-35 per cent is generally considered good.

• 30-35 per cent: Indicates good financial management.
• 36-39 per cent: An acceptable range with a manageable burden.
• 40-49 per cent: A high burden, and lenders may conduct a stricter assessment and impose stricter terms if the loan is approved.
• 50 per cent and above: High chances of rejection, since half of the income already goes towards debt payments.

How to manage the debt-to-income ratio?

DTI is one of the many factors that a lender assesses while approving a loan. The borrower's income stability, credit profile, past defaults, and repayment history also matter.

Thus, a person can improve their DTI before applying for a new loan by following these steps:

• Pay off existing debts.
• Avoid taking unnecessary loans.
• Even if applying for a loan, choose one with lower EMIs.
• Increase monthly income.
• Check and correct any errors regarding loan repayments.