You are looking to purchase your dream home. After rounds of selection, you have finally found the ideal place that ticks all the requirements of your dream home. The next step is to apply for a home loan to pay for your dream property. You check your credit score and it ranges on the higher end.
You then approach a home loan lender requesting a loan. To your surprise, your home loan is denied. You are shocked. What could be the reason when you have got a pretty good credit score?
The culprit could be your high debt to income ratio that is causing you trouble in getting your home loan sanctioned. Wondering what this ratio is that we are talking about?
Worry not, here in this guide, we give you all that you need to know about debt-to-income ratio and how it impacts your home loan eligibility.
What is the debt-to-income ratio?
Just like your credit score, the debt-to-income ratio is another factor that you should keep an eye on, to improve your creditworthiness.
As the name implies, this number is arrived at by dividing your monthly debts – credit card payments, EMIs of other loans that you’ve taken: car loans, personal loans, etc. – by your monthly income.
Abbreviated as DTI, the debt-to-income ratio helps lenders evaluate how much additional debt you can comfortably take on top of your existing debts. Unlike credit scores, where the higher the number, the better, you need to aim for a lower debt-to-income ratio. A low debt-to-income ratio indicates that your income is much higher than your debts.
How is the Debt-to-Income Ratio Calculated?
Calculating the debt-to-income ratio is quite simple. All you have to do is add your monthly debt payments and divide this amount by your total monthly income.
Let’s say, your monthly debt payments include:
Personal loan EMI – Rs. 5000
Car loan EMI – Rs. 10,000
Average monthly credit card payments – Rs. 8000
Total Monthly Debt – Rs. 5000 + Rs. 10,000 + Rs. 8000 = Rs. 23,000
Your monthly salary is Rs. 80,000
Now your debt to income ratio is: 23,000 / 80,000 * 100 = 28.75%.
Now that you have got a basic understanding of the DTI ratio let's answer a few FAQs on it.
What does your Debt-to-Income Ratio Numbers mean?
Once you have calculated the DTI ratio, you need to understand better where you stand. Note that the ranges listed here are general guidelines, and the decisions by lenders vary based on several other factors.
What does it mean when your DTI ratio is:
35% or lower – You are good. Your overall debts are at a manageable level.
When your DTI ratio is 35% or lower, it implies that you have adequate money remaining out of your monthly budget after you have paid your debts, bills, and handle other expenses. Lenders consider you as a favourable candidate for home loans and other big-ticket loans.
36% to 49% - Not bad. But, you’ve got room to improve.
A DTI ratio between 36 to 49% is considered manageable. However, to improve your chances of securing the loan and reducing interest rates, you can consider lowering your DTI. When you lower your DTI, you are better positioned to handle unforeseen expenses.
Higher than 50% - You need to take steps to bring down your DTI.
Lenders consider borrowers with DTIs more than 50% as risky borrowers, thereby limiting your chances of securing loans.
FAQs on Debt-to-Income Ratio
Why is the debt-to-income ratio poor, when the credit scores are high?
It’s because both credit scores and DTIs gauge different aspects of your finances. The credit score determines how you handled loan products in the past and your repayment trustworthiness. The debt-to-income ratio, on the other hand, measures your future capability to handle additional loans.
Is there an ideal number that I should aim for?
Try to keep your debt-to-income ratio below 35%. It means you have sufficient amount left in your monthly budget after paying your bills, loan EMIs and other expenses. When your DTI ratio is 35% or lower, the chances of banks approving your home loan is higher.
Is there a specific limit for the ratio beyond which lenders do not sanction home loans?
While there's no fixed hard limit, most lenders hesitate sanctioning loans to borrowers with a debt-to-income ratio of more than 40%. When your DTI exceeds 40%, you're considered a risky borrower.
However, note that this is a general guideline. Most banks consider several other factors beyond the DTI – like your employment status, credit scores while approving home loans.
Smart Tips to Lower your Debt-to-Income Ratio
Has your home loan application been rejected? Do you suspect your high DTI as the reason for rejection? Worry not, here are a few smart ways to bring it down, and improve your prospects of securing a home loan.
Try to increase the EMIs you are currently paying. By making extra payments on your existing loans, you can lower your overall debts, thereby bringing down your debt-to-income ratio quickly.
Do you have a habit of paying only the minimum outstanding amount on your credit card? Make sure to settle all your outstanding credit card dues, before you apply for a big-ticket loan like a home loan.
Also, avoid purchasing expensive items on your credit card before you apply for an additional loan, as it can skew your debt-to-income ratio negatively.
Try to save extra to make a larger down payment. This way, the amount you borrow reduces, improving your chances of loan sanction.
If your debt-to-income ratio is weak, make sure to recalculate it monthly to see if it has reduced.
The other approach beyond reducing your existing debts is to check if you can increase your salary. Get in touch with your HR manager at work to see if it’s possible whether they can give you a raise.
Try if it’s possible to refinance your existing loans with another lender for an attractive interest rate.
Find Ways to Decrease your DTI and Improve your Chances of Securing a Home Loan
Keeping your debt-to-income ratio low plays a crucial role in increasing the chances of securing a home loan. It also gives you peace of mind, as you know that debts don't overburden you.