HOW YOUR DEBT TO INCOME BECOMES A REPORT CARD FOR YOUR LOANS

[Sriram Somayajula]

What is DTI?

Debt to Income Ratio or DTI (as its known more popularly) is a self-explanatory term or rather a measure that calculates the your debt repaying capacity vis-a-vis your monthly gross income. As crucial as it sounds, it is a measure that actually determines your credibility in the market when it comes to acquiring loans (or any other form of credit sanctioned in the Indian market). The moneylenders here have a clearer understanding of the balance between your monthly gross income, and your current debt scenario (if they exist) at the moment.

Let us understand how DTI is calculated and how it may affect your day-to-day financial decisions through this weekly blog at IndigoLearn. 

Calculating DTI has a simple formula:

DTI = Total of monthly debt payments / Monthly gross income

Now you must remember to use a gross variable here in the formula for the debt to ensure accuracy in calculation. This will also give you a realistic figure and help you get more clarity on your current standpoint with regard to your ability to acquire loans in the market. Hence, you take your time, but do a thorough compilation and addition of all your debts

• Mortgages
• Credit cards
• Loans
• Other miscellaneous expenses

How do moneylenders review your DTI?

Once you understand your standpoint regarding your debt repaying capacity, it becomes easier for you to make a decision with regard to how do you plan on using this DTI to your benefit. In case your DTI is higher than your expectations (or the market’s/bank’s threshold), you are alarmed to reduce your debts. There are several ways to go about it, such as cutting down on recurring debt sources or generating more income. 

Most banks in India have a threshold of 40% as DTIs eligible for credits/loans. Any figure higher than this could lead to rejection, which in turn could waggle your future financial decisions or even security plans for that matter. Not just that, it also means your ability to handle the following things is weak.

• Emergencies
• Unforeseen situations
• Medical emergencies
• Home loans
• Student’s loan
• International trips

You may not be able to save enough money by the end of the month to use it for a situation that requires a lump sum transaction on an immediate basis.

DTI and its connection to your day-to-day scenarios.

Let us imagine a person named Mr. Rakesh Kumar whose monthly income is INR 45,000. In addition to this daily expenses, he has INR 500 as his credit card bill, INR 5000 to pay as EMI for his brand new purchased scooter, and INR 10,000 to pay as EMI for a student’s loan he’d taken for his graduation 2 years ago. Now this makes his total debt on a monthly basis shoot up to INR 20,000, in turn his DTI shoot up to 44%. Considering he’s been working for 2 years now, he aspires to purchase a 2BHK for himself for which he now wants to apply for a home loan.  

He approaches Bank A for the same, but is rejected by the bank because of the following reasons.

• It is doubtful of his capacity to accommodate another loan in addition to his other debt payments that are recurrent.
• The fact that they also require some amount of time to be settled, the bank again has its own shares of uncertainty.
• They want to seek assurances from the borrower to avoid losses/frauds/hustle.
• His high DTI  may waggle their trust in his capacity to manage extra financial load.

The above scenario stands true if he needs to borrow money in case of a medical emergency as well. 

Is there a connection between your DTI and credit score?

Now, several factors influence your DTI including the number of your credit accounts, credit limits and its ratio to the utilization of the same, late payments and other deliquicency/illegal activities. Now you must not confuse with credit utilization with DTI. Credit utilization is basically your credit utilized with regard to your existing credit limit, whereas DTI calculates your existing debt with regard to your monthly gross income.

It is also important to understand that even though credit is a variable used to calculate DTI, your DTI has nothing to do with your credit score or your credit report. That is because your credit report does not include your monthly gross income as a variable to decide on your ability to use credit. 

Hence, Rakesh’ DTI again becomes only an external factor for the banks to assess his credibility. If he’s earned enough credit scores in the past to apply for a loan, his chances of getting one might increase. Remember, it is always a matter of how one balances these figures in their life.

Nonetheless, your DTI is an important measure that not only eases your process of acquiring external help for financial matters, it also ensures you balance your current financial situation vis-a-vis your income.