When it comes to taking a loan, most people often worry too much about their credit scores at the expense of debt-to-income ratio (DTI). DTI is a financial tool used to calculate the relation between your debt and income. The DTI can be found by dividing your recurrent monthly debt and your gross monthly income. The result is used to anticipate whether you can afford to pay the required monthly instalment based on your income. Also, the debt-to-income ratio will determine how much a risk you are to the lending company.
Most lending companies use the DTI for quick loan approval rate. While small businesses use the debt service coverage ratio, most banks still use the debt-to-income ratio for sole proprietors. Sole proprietors are not considered separate entities from the owner and therefore use the debt-to-income rate during a loan application process.
Importance of The Debt-To-Income Ratio
The debt-to-income financial ratio is not only crucial for money lenders but also for borrowers. It protects you from putting yourself into a financial crisis dip by taking a loan that you will struggle to pay or fail to pay, hence leading to deliquency. DTI is vital for two reasons.
– Plays a significant role in how eligible you are for a loan
– It indicates your current financial situation
– Shows whether you are eligible to take multiple loans
– A borrower with low debt-to-ratio is expected to receive credit with better terms
Qualifying for a loan is not a big deal. The issue is whether you can afford the debt consolidation loan. Calculating your DTI will analyze your existing debts and understand if taking another loan is a good idea or not. Additionally, the DTI ratio will helps you realize how much mortgage you can realistically borrow. Knowing your DTI before going to a lender will save you a whole lot of time.
For licensed moneylenders, the DTI helps them to determine how much one is able to repay monthly for your potential loan. A borrower whose DTI is at high-risk will likely see their loan application rejected.
How to Calculate Debt-To-Income Ratio
Simply divide the total monthly recurring debts from your total monthly income and multiply it by 100 to convert it into a percentage.
Gross monthly debt/Total Monthly Income *100 = Debt-To-Income Ratio
Gross Monthly Debt
Your gross monthly debt includes all of the recurring monthly debts under you, such as mortgages, car loan payment, credit card balance, student loans, etc. Use the minimum deposit amount when adding your total monthly debt.
Total Monthly Debt
It is your monthly income before tax. To get your average monthly income, divide your annual income by 12. However, if you are paid on an hourly basis, multiply your hourly wages by the hours you work each week. Multiply the figure you will get by 52 and divide it by 12 to get your average monthly gross income.
The lower the DTI ratio, the better for you as a borrower. It means you can comfortably service your loan, and the lender is likely to approve your loan. However, a high DTI ratio means that you will struggle to repay your loan, making it difficult for lenders to approve your loan. Most loan lenders in Singapore consider a borrower with 36% or lower a good DTI rating and 43% or more a bad DTI rating.