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Debt-to-income ratio for personal loan – Meaning, calculation & eligibility impact

Debt-to-income ratio for personal loan – Meaning, calculation & eligibility impact

Imagine applying for a personal loan and feeling confident about your income. Your salary looks good, your credit score is decent, and you expect quick approval. But the lender still rejects your application. The reason might be something many borrowers often overlook: you do not meet the lender’s criterion of debt-to-income ratio for personal loans.

Many borrowers focus only on their monthly income and credit score when applying for a personal loan. However, lenders also look at how much of that income is already committed to existing loan EMIs and regular financial obligations. If a large portion of your income is already tied up in repayments, the lender may hesitate to offer a new loan.

In this blog, you will learn in detail about the meaning of the Debt-to-Income (DTI) ratio, how it affects your personal loan eligibility, and what can be the ideal DTI ratio for loan approval. Keep reading.

What is the Debt-to-Income (DTI) ratio?

The debt-to-income ratio shows how much of your monthly income goes towards the repayment of your existing debt. A high DTI ratio means a significant portion of your income is already being used to service loan EMIs. In contrast, a lower DTI ratio indicates that you have a strong ability to manage debt and repay loans.

In other words, your DTI ratio compares your total monthly debt payments with your gross monthly income. Gross income means your earnings before taxes and deductions. Debt payments may include EMIs for personal loans, home loans, car loans, or credit card dues. That is why this ratio is sometimes known as the EMI-to-income ratio.

Here’s the basic formula to calculate the DTI ratio:

DTI Ratio = (Total monthly debt payments / Gross monthly income) x 100

Why does the debt-to-income ratio matter for personal loans?

Your debt-to-income ratio plays a crucial role in determining your personal loan eligibility. Lenders often use this ratio to assess your repayment capacity and financial stability. It helps them understand what portion of your monthly income is going towards existing debts and financial obligations, and whether you can comfortably handle another EMI. If the ratio is too high, the lender may refrain from approving your personal loan application.

Basically, analyzing borrowers’ debt-to-income ratio for personal loan applications helps the lender with risk assessment. A lower ratio usually suggests lower risk, while a higher ratio may increase the chances of loan rejection or stricter loan terms.

How does the DTI ratio impact your personal loan approval?

We have already discussed how the debt-to-income ratio for personal loan applications can influence a lender’s decision to approve or reject a loan. However, its role does not end there. This ratio can also affect the loan amount, repayment tenure, and interest rate offered to the borrower.

If your DTI ratio is lower, lenders may feel more confident about your repayment capacity. In such cases, they may offer you a higher loan amount or a flexible repayment tenure. You can also secure a lower interest rate. On the other hand, if the ratio is high, the lender may reduce the loan amount or offer a shorter tenure.

Also,read – What Is FOIR? Calculation Of FOIR On Personal Loan

How to calculate your debt-to-income ratio?

You can calculate your DTI ratio using the simple formula mentioned above. Here are the steps for the same:

1. Evaluate your gross monthly income. This is your total monthly income before taxes and deductions. Make sure to consider income from all sources, including salary, freelance work, rent, and short-term gains from investments.

2. Add your monthly debt payments. Include all loan EMIs, credit card payments, and other regular debt obligations.

3. Divide your total monthly debt payments by your gross monthly income.

4. Multiply the result obtained in step 3 by 100 to calculate your debt-to-income ratio percentage.

DTI calculation example by numbers

Let’s consider a practical example to understand how to calculate the DTI ratio. Suppose your monthly salary is Rs. 60,000 and you earn Rs. 20,000 from rent and other sources. It means that your gross monthly income is Rs. 80,000 (60,000 + 20,000).

If you are paying Rs. 15,000 as your home loan EMI and Rs. 5,000 as your car loan EMI, your total monthly debt payments amount to Rs. 20,000 (15,000 + 5,000).

Using the formula, your DTI ratio is [(20,000 / 80,000) x 100], i.e., 25%.

Also,read – Personal loan limits in India: What’s the maximum you can borrow?

What is the ideal debt-to-income ratio for a personal loan?

Lenders usually prefer borrowers with a lower debt-to-income ratio for personal loan applications. In most cases, the ideal EMI-to-income ratio is considered to be around 20% to 40%. A DTI ratio of less than 20% reflects an excellent financial position, whereas a DTI ratio above 40% reflects high debt levels. Such borrowers may find it difficult to get personal loan approval.

However, the exact limit can vary depending on the lender, your credit score, income stability, and overall financial profile.

Eligibility criteria linked to the debt-to-income ratio

Your debt-to-income ratio is one of the most crucial factors that determine your personal loan eligibility. However, this ratio is not the only factor lenders consider in their decision-making process. They also evaluate other aspects such as your income stability, employment type, and credit score before approving a loan.

In most cases, the final decision is based on a combination of these factors. For example, a lender may still approve a loan application even if the DTI ratio is slightly high, provided the borrower has an excellent credit score and a stable income.

Practical ways to improve your debt-to-income ratios

You can improve your DTI ratio by following a few simple tips. One such step is to repay small loans or credit card dues to reduce your total monthly debt payments. You can also try to increase your gross monthly income through bonuses, side work, or additional income sources.

Another useful step is to avoid taking new credit frequently. This helps you maintain your overall debt position. You may also consider refinancing high-interest loans to reduce your monthly EMI burden.

Avoiding or postponing a big-ticket purchase, such as a car, TV, or furniture, may also indirectly help you improve your DTI ratio. It’s because you’ll use less credit, and your overall monthly financial obligations will stay within manageable levels.

Common mistakes that increase your DTI ratio

Here are some common mistakes that can unknowingly increase your DTI ratio:

  • Taking multiple short-term loans: Multiple small-ticket loans can increase your overall debt obligations. This, in turn, can swell your fixed obligation to income ratio.
  • Excessive credit card usage: Higher credit card usage can increase your debt obligations as well as your credit utilization ratio. Thus, it impacts both your DTI ratio and credit score.
  • Ignoring hidden liabilities: Small liabilities, such as minor credit card bills, BNPL (Buy Now Pay Later) purchases, etc., are often overlooked. But they can also increase your DTI ratio.
  • Not closing unused loan accounts: Even inactive credit accounts can affect your overall financial profile and the DTI ratio.

Also,read – Personal loan for CIBIL score of 550: How to get approved

Key points to remember about DTI and personal loans

As explained, your debt-to-income ratio plays a crucial role in determining your eligibility for a personal loan. Here are a few points to keep in mind:

  • A lower DTI ratio indicates better repayment capability, and vice versa.
  • An ideal debt-to-income ratio for personal loans is around 20% to 40%. It means the maximum EMI percentage of salary should hover around 40%.
  • Lenders also consider your credit score, income stability, and employment type while determining personal loan eligibility.
  • If your DTI ratio is above the acceptable level, it’s better to first improve it before applying for a new loan.

Maintaining a healthy DTI ratio can make it easier to qualify for a loan and manage repayments comfortably.

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FAQs

What is a Debt-to-Income (DTI) ratio?

The debt-to-income ratio shows how much of your monthly income goes toward paying existing debts. It compares your total monthly EMI payments with your gross monthly income. Lenders use this ratio to check whether you can comfortably handle another loan.

How do lenders calculate the DTI ratio for a personal loan?

Lenders calculate the DTI ratio for a personal loan by comparing your total monthly debt payments with your gross monthly income. They add all EMIs, credit card dues, and other obligations. This total is divided by your monthly income and then multiplied by 100 to get the percentage.

What is the ideal DTI ratio for personal loan approval?

The ideal DTI ratio for personal loan approval is usually below 40%. This means your total EMIs should not exceed 40% of your monthly income. A lower ratio shows lenders that you have enough income left to manage a new loan comfortably.

Does a high DTI ratio lead to personal loan rejection?

A high DTI ratio, i.e., above 40%, often leads to the rejection of a personal loan application. However, lenders also look at your income stability, credit score, and employment type when making a decision. In most cases, the final approval or rejection is based on a combination of these factors.

How can I improve my debt-to-income ratio quickly?

You can improve your debt-to-income ratio by reducing your existing debts. Try to repay small loans or clear credit card dues to lower your monthly EMIs. Avoid taking new loans for some time. Increasing your income can also help improve the ratio.

Is the DTI ratio the same as the credit score?

Although they both reflect your repayment capacity, your DTI score and your credit score are not the same. The DTI ratio shows how much of your monthly income goes toward paying existing debts. A credit score reflects your repayment history and credit behavior. Lenders usually check both before approving a personal loan.

Does the DTI ratio affect the personal loan interest rate?

Yes, the DTI ratio can affect the personal loan interest rate in some cases. If your ratio is low, lenders may see you as a lower-risk borrower and offer better terms. If the ratio is high, the lender may charge a higher interest rate or reduce the loan amount.  
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