If you are planning to take a home loan, then you should be aware of debt to income ratio and the role it plays in getting a loan sanctioned.
When you apply for a home loan, the lender or bank conducts a debt to income ratio (DTI) analysis to evaluate your ability to pay back the loan. The lender will sanction the loan amount only if this ratio is within the specified limit. The debt to income ratio formula varies slightly according to the type of creditor or lending institution. A generally recommended ratio is 15%.
So, what is debt to income ratio and how to calculate it?
The debt-to-income ratio is calculated by dividing your total monthly payments by your gross monthly income (without tax deductions). This ratio helps the bank to evaluate your ability to manage the monthly payments to repay the loan amount.
It also signifies your overall financial health and helps you understand whether you can afford to take the new loan. If you have a lower DTI ratio, it means that you have fewer obligations and are more likely to keep up all of your existing payments.
Here are some facts that you need to know about the debt to income ratio and how you can achieve a good percentage to get your loan approved.
The debt to income ratio is a ratio that shows your capacity to pay back the loan. If your monthly debt or loan payback amount is higher, it becomes more difficult for you to get another loan as your DTI will be higher.
For instance, if your total debt or loan payment is Rs.5000/month and your salary is Rs. 20000/month, then your debt to income ratio is 5000/20000 = .25 or 25%. So to achieve a lower DTI and increase your chance of getting another loan, you should have less amount of monthly loan payments or monthly debts.
Every organization will have a specified margin for debt to income ratio for sanctioning loans. While for a credit card company, a higher ratio is acceptable, the same may not apply for a home loan. If it is a long term commitment like a home loan, usually the ratio will have to be comparatively low.
As mentioned earlier, the debt to income ratio of 15% is considered a safe figure. This means that you have enough money to take care of your monthly needs and to pay back the loan regularly. A low debt to income ratio shows that you will be able to dedicate at least 30% of your monthly earnings toward the loan, making you a reliable borrower.
Debt to income ratio is just one of the deciding factors that influence your capacity to take a loan. Apart from the DTI ratio, various other factors like down payment, legal documents, etc. also plays a key role in determining your ability to take a loan.
Another important factor that you must keep in mind before taking any loan is maintaining a clean credit record. Having a history of paying back loans on-time and clearing the credits will help you in the loan approval process. If you have more credit payments pending, it will also impact your debt to income ratio figure. Also, a large debt amount with a consistent payment history is considered to be better than a small debt to income ratio with a poor credit history. So try to maintain a clean credit history to ensure easier home loan approvals.
Maintaining a low debt to income ratio is essential for you not just to enhance your chances of getting a home loan, but will also be applicable for other types of loans . You must have a clear idea about your short-term and long-term expenses before applying for a new home loan. We advise you to do a thorough study of your existing debts and also keep an eye on your spending habits to be on the safe side in terms of financial health. Also, you must carefully go through the terms and conditions of the bank before finalizing a loan.
We hope that by now you have got a fair idea about the debt to income ratio and its role in home loan approvals. Keep these home loan approval tips in mind while preparing to buy your dream home.
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