Debt-to-income (DTI) ratio is a key measure lenders use to evaluate your financial health. It influences the loan amount, interest rate, and credit limits you can qualify for.
When you apply for credit, lenders calculate your DTI to understand how much of your income is already committed to debt repayments. Below is a clear explanation of why this ratio matters and how to compute it using a simple formula.
Understanding your DTI Ratio
Your DTI ratio represents the percentage of your monthly income that goes toward repaying debts. It directly affects your creditworthiness and the terms lenders offer. Financial advisers typically recommend keeping your DTI at 35% or lower to maximize your chances of approval and secure better interest rates.
Lenders favor a lower DTI because it suggests you have sufficient disposable income to handle additional repayments. A high DTI signals that your income may be stretched, increasing the likelihood of missed EMIs or defaults and indicating greater reliance on borrowed funds. For these reasons, a higher DTI can reduce approval chances and lead to higher interest rates.
Maintaining a low DTI not only helps with loan approvals but also positions you to receive more competitive rates. Conversely, a high DTI can limit options and increase borrowing costs.
DTI ranges and what they typically mean:
- 10% or less: Excellent — you can typically access loans at attractive interest rates with minimal hassle.
- 11–20%: Very good — lenders are likely to offer competitive loan terms.
- 21–35%: Acceptable — you can often get approved if other eligibility criteria are met, though lowering this further is advisable.
- 36–50%: Riskier — approvals become harder and interest rates may be higher as a significant portion of income services debt.
- More than 50%: Challenging — qualifying for new credit is difficult and costly.
Debt-to-income ratio formula and calculation
The DTI is calculated with a straightforward formula:
DTI percentage = (Total Monthly Debt / Net Monthly Income) × 100
Example:
Manvi plans to apply for a personal loan and wants to check her DTI. Her monthly obligations are:
- Car loan: ₹15,000
- Credit card bill: ₹5,000
- Net monthly income: ₹80,000
Total monthly debt = ₹15,000 + ₹5,000 = ₹20,000
DTI percentage = (₹20,000 / ₹80,000) × 100 = 25%
With a 25% DTI, Manvi stands a good chance of loan approval.
Note: DTI applies to individuals. For companies, a different metric called the debt ratio is used, which compares total debt to total assets.
How to Improve Your Debt-to-Income Percentage
Lowering your DTI can improve your credit profile and borrowing options. It requires consistent budgeting and smart financial moves. Consider the following strategies:
- Target and pay off the smallest debts first to build momentum.
- Avoid taking on new loans while reducing existing debt.
- Prioritise clearing credit card balances to lower interest costs.
- If feasible, increase EMI payments to close loans faster and reduce outstanding debt.
- Look for ways to increase income, such as freelancing, a side job, or asking for a raise.
- Cut unnecessary expenses and redirect savings toward debt repayment.
Reducing high-interest balances or consolidating multiple high-cost debts into a lower-interest loan can also accelerate improvement in your DTI.
Frequently Asked Questions about Debt-to-Income Ratio
What is the ideal debt-to-income ratio?
A DTI under 35% is generally considered ideal for obtaining affordable credit.
How do you calculate the debt-to-income ratio?
Add all monthly debt payments, divide that total by your monthly income, and multiply the result by 100 to get the percentage.
Is a 40% debt-to-income ratio good?
A 40% DTI is considered fair but higher than the recommended threshold. It may limit access to the most competitive credit products and could result in higher interest rates.
Is 11% a good debt-to-income ratio?
Yes. An 11% DTI is strong and should make it relatively easy to obtain credit, assuming you meet other eligibility requirements.
What does the debt-burden ratio mean?
The debt-burden ratio is another term for the debt-to-income ratio; it reflects the portion of your monthly income used for debt repayments.