How Your Debt-to-Income Ratio Impacts Personal Loan Approval

November 16, 2024 By: Nisha Chawla

When applying for a personal loan, lenders like banks and NBFCs evaluate several factors, such as your credit score, income, age, and profession. Among these, the debt-to-income (DTI) ratio is one of the most critical aspects. This ratio reflects how much of your monthly income goes towards repaying existing debts and plays a significant role in determining your loan eligibility.

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

The DTI ratio shows the percentage of your monthly income spent on debt repayment, including loan EMIs and credit card dues. A lower DTI ratio indicates better financial health and higher chances of loan approval.

How to Calculate DTI Ratio

The formula for calculating the DTI ratio is:

DTI Ratio=(Monthly Debt RepaymentsMonthly Income)×100\text{DTI Ratio} = \left( \frac{\text{Monthly Debt Repayments}}{\text{Monthly Income}} \right) \times 100DTI Ratio=(Monthly IncomeMonthly Debt Repayments​)×100

For instance, if your monthly income is ₹1 lakh and your total monthly debt repayment is ₹20,000:

DTI Ratio=(20,0001,00,000)×100=20%\text{DTI Ratio} = \left( \frac{20,000}{1,00,000} \right) \times 100 = 20\%DTI Ratio=(1,00,00020,000​)×100=20%

In this case, your DTI ratio is 20%, which is considered excellent.

What is a Good DTI Ratio for Personal Loans?

While specific requirements vary across lenders, a DTI ratio of 35% or lower is generally considered ideal for personal loans. Here’s a breakdown:

• DTI below 35%: High chances of loan approval.
• DTI between 35%-45%: Application may undergo stricter scrutiny.
• DTI above 45%: Low approval chances, as repayment capacity is perceived as limited.

A DTI ratio of 35% indicates a balanced financial profile, where most of your income is free for other expenses and savings after debt repayment.

Why Do Banks Focus on DTI Ratio?

Banks and NBFCs assess the DTI ratio to understand your ability to handle additional debt. For example:

• DTI under 35%: Indicates financial stability and sufficient room for new debt.
• DTI above 45%: Suggests higher financial strain, making lenders hesitant to approve loans.

By prioritizing applicants with lower DTI ratios, lenders minimize their risk of defaults.

How to Improve Your DTI Ratio

If your DTI ratio is higher than ideal, here are some effective ways to reduce it:

1. Make Additional EMI Payments

If possible, pay extra towards your existing loans to reduce the principal amount and lower your debt.

2. Foreclose Smaller Loans

If you have multiple loans, consider foreclosing smaller ones to decrease your overall debt burden.

3. Increase Loan Tenure

Extending the tenure of your loan reduces the monthly EMI, improving your DTI ratio. However, this may increase the overall interest paid.

4. Postpone Big Expenses

Delay significant expenses for a few months and use that money to pay off debts.

5. Avoid Taking New Debt

Until your DTI ratio improves, avoid applying for new loans or increasing your credit card usage.

Key Takeaways

Maintaining a low DTI ratio is crucial for improving your chances of personal loan approval. By managing your finances effectively, you can strike the right balance between income and debt, ensuring financial stability while meeting your borrowing needs.