with the process. One bad decision can greatly affect a homebuyer’s overall financial health.
One of the most crucial things that one needs to evaluate is whether they are ready in every aspect to buying a house or not. These include the homebuyer’s age, monthly income, and current financial responsibilities. Before taking a home loan, one should make sure that they will be able to pay their home loan EMIs, and that too, in a timely fashion.
One of the best ways a homebuyer can evaluate their readiness to buy a new house is by analysing their debt-to-income ratio for a home loan. This ratio helps in understanding whether a homebuyer will be able to repay their home loan EMIs and decide if one should apply for a fresh home loan at a particular time.
What is a debt-to-income ratio?
A debt-to-income ratio, also known as the debt burden ratio and the DTI ratio, gauges how much money borrowers spend on repaying their debt against how much money they earn during a month. In the context of a home loan, the DTI ratio refers to the ratio of the home loan EMI amount to the homebuyer’s monthly income.
The DTI ratio is calculated by dividing an individual’s total debt payments for a month by their gross monthly income. Lenders, such as banks or mortgage companies, use the DTI ratio to assess the risk level associated with lending money to a borrower.
The DTI ratio of a homebuyer reflects their creditworthiness and ability to repay the home loan EMIs on time. A high DTI ratio indicates the borrower’s inability to pay their home loan EMIs, reducing their chances of securing a fresh home loan. On the other hand, a low DTI ratio means that the borrower is creditworthy, thereby improving their chances of getting a new home loan from a lender.
How to calculate the DTI ratio?
One can calculate their DTI ratio by using a simple debt-to-income ratio formula. Here, they will need to divide their total loan EMI with their gross monthly income and then convert the result into a percentage.
For example, let’s say a person is paying ₹25,000 as loan EMI every month, and his gross monthly income is ₹1 lakh. To calculate his DTI ratio, he would need to divide ₹25,000 by ₹1 lakh, which comes out to 0.25 or 25%. Similarly, if someone has a debt-to-income ratio of 30%, he will have to pay 30% of his income towards loan repayments.
One can also use an online debt-to-income ratio calculator to gauge their DTI ratio. All they will need to do is enter their cumulative loan EMI amount and gross monthly income in the calculator, which will instantly display their DTI ratio.
Importance of the DTI ratio
A person’s DTI ratio, or the debt burden ratio, is crucial in many ways. First of all, it allows them to gauge whether they should apply for a fresh home loan or not. Since a home loan involves a significant sum of money, a homebuyer should evaluate their DTI ratio before applying.
A general rule of thumb is keeping their DTI ratio within 43%. In the case of a home loan, one should apply for a new loan only if their DTI ratio (after considering the home loan) is 36% or less. If the DTI ratio is higher than this, it may indicate that the borrower has too much debt compared to their income, making it more challenging to manage their debt payments.
Besides, the DTI ratio of a borrower also helps a lender decide if it should approve their loan application. A low DTI ratio increases the chances of a homebuyer getting a home loan at a competitive interest rate.
Understanding and managing one’s DTI ratio is essential for financial stability, especially when applying for loans or credit.
The debt-to-income ratio is a crucial factor that helps decide whether a person should apply for a new home loan. As a homebuyer, one can use an online debt-to-income ratio calculator to know their DTI ratio for a home loan and then take a well-informed decision.
If someone has a high DTI ratio, they can take several steps to bring it down before availing of a home loan. For instance, one can foreclose their smaller loans to reduce their EMI burden. Additionally, one can opt for a lower loan amount or a higher tenure to keep their DTI ratio in check.
Disclaimer- This article is based on the information publicly available for general use as well as reference links mentioned herein. We do not claim any responsibility regarding the genuineness of the same. The information provided herein does not, and is not intended to, constitute legal advice; instead, it is for general informational purposes only. We expressly disclaim/disown any liability, which may arise due to any decision taken by any person/s basis the article hereof. Readers should obtain separate advice with respect to any particular information provided herein.