While borrowing money, lenders would like to sit with a list of parameters. Only after qualifying each and every parameter generally lenders used to agree with lending money. When it comes to lending money, one parameter that becomes important for almost all money lenders is the Debt-To-Income (DTI) ratio.
A person tries to complete all his expenses within his total income. But whenever he wants to purchase something beyond the grab of that person right now, he wishes to borrow money. After borrowing money, the person needs to repay the outstanding amount either by monthly instalments or one-time repayment. Naturally, people would like to repay the entire outstanding by dividing it into monthly instalments.
Now, while paying monthly instalments, there comes the concept of the DTI ratio. Here we will discuss everything about the DTI ratio and all its limitations so that you may better understand how to keep it up to the mark correctly.
Definition of Debt-to-Income (DTI) Ratio
While repaying through monthly instalments, you need to keep a certain amount of money aside to avoid fewer problems during payment. So, it is a percentage of money that a borrower utilises to pay from total net income. It is known as the Debt-To-Income Ratio.
It plays an essential role during the sanction of the fund. The only reason behind it is that the Debt-To-Income ratio clearly defines how much money one needs to pay in the form of repayment and how much is left within the hand. Moreover, DTI also works like a parameter that represents the financial stability of the borrower.
Based on that ratio, a lender can judge how much additional repayment he can carry without hampering his financial stability. Apart from judging financial stability, a lender also gets the assurance that the fund which he lent is recoverable as it does not ruin the financial stability of the borrower.
Important factors about Debt-to-Income (DTI) Ratio
To make the concept clearer, here we will discuss important factors of the DTI ratio.
- The ideal percentage of DTI
Do many people often ask what the ideal percentage is in the Debt-To-Income ratio? While answering this question, often, two related subcategories came into existence. One is low DTI, and the other is high DTI. Undoubtedly, low DTI is better than high DTI.
Perhaps you think that why DTI low is better? Actually, here low ratio means a borrower does not repay a considerable amount of money for repayment. On the other hand, high DTI represents a huge amount of outstanding debt within the market. Now, this will definitely become the cause of rejecting loan applications.
However, if the borrower faces any rejection, then he may apply for poor credit loans from direct lenders. The will lend you money even if a person has high DTI.
- Monthly income range
The debt-To-Income ratio strongly depends upon the total income of a person. Actually, the amount one pays is entirely out of his income range. The source of income could be anything, e.g. business income, employment income, investment income etc. However, a borrower used to repay his debt out of his income.
In any condition, if his income source stops, there will be no source of income. As a result, a borrower becomes a loan defaulter quickly. Besides, the amount of salary also plays a significant role in this ratio because depending upon a borrower’s total salary, a lender judges his ability. Therefore, the total income range also plays a substantial role in the Debt-To-Income ratio.
- Calculating process of DTI ratio
The process of evaluating the DTI ratio is quite simple. Whenever a lender looks at a person’s net income, he starts calculating through a particular method. In the beginning, the lender may ask for how much debt a person pays in total per month. After that, his entire income is taken into consideration.
Now, the total amount spent for paying the outstanding debt is divided by net monthly income. After that, the result is the desirable ratio upon which a lender relies primarily. However, if the result comes into decimal, then multiplying it by 100 is one of the most common practices.
- Inclusion of Debt-To-Limit ratio
Another concept that is almost synonymous with DTI is the Debt-To-Limit ratio. Usually, after calculating both of these ratios, sometimes a lender takes the decision whether he should lend money to that particular borrower or not. However, the Debt-To-Limit ratio is also termed the Credit Utilisation Ratio.
The only reason behind building the connection between DTI and DTL is that both denote the characteristics of a borrower. It also determines how a person actually is as a borrower. At the same time, DTI represents a borrower’s remaining income after paying monthly instalments. On the other hand, the DTL ratio points out towards a borrower’s limitation of borrowing.
Restrictions of Debt-to-Income (DTI) Ratio
There are some limitations of this particular concept. Before applying this strategy to judge the financial stability of a person, one must know these,
- The concept only helps money lenders to know about those borrowings conducted under pen-paper mode. Apart from that, if a person borrows money from a relative, it does not come under history.
- Apart from borrowing habits, this concept cannot offer any other information about the borrower’s personal finance.
So, these are some limitations of using this method. There is no doubt that lending money, especially when it is an unsecured loan, then only evaluating through DTI will not mitigate the entire risk.
Lisa Ann has developed a well-experienced professional career. From managing the staff of more than 50+ loan experts at Fastmoneyfinance to boosting the delivery of various loan offers, she has acquired many challenging roles to come out with the best results for the company. Lisa Ann is a Senior Content Author and the Chief Financial Advisor at Fastmoneyfinance. To back her massive experience in the UK’s financial industry, she has the postgraduate degree and diploma in Business and Finance.