Are you familiar with “The Golden Rule” that lenders employ to assess your Expense-to-Income Ratio during a bank statement analysis?
What is a debt-to-income ratio?
DTI stands for debt-to-income ratio. It is a measure of how much debt you have compared to your income. Lenders use your DTI to assess your ability to repay a loan. A higher DTI means that you have less disposable income to make loan payments, which can make it more difficult to qualify for a loan.
For example, if your monthly debt payments total ₹2,000 and your monthly gross income is ₹5,000, your DTI would be 40%.
Here is a table of what lenders typically consider to be good, fair, and bad DTI ratios:
| DTI Ratio | Assessment |
|---|---|
| Less than 36% | Good |
| 36% to 42% | Fair |
| 43% to 50% | Poor |
| Over 50% | Very poor |
If your DTI is high, there are a few things you can do to improve it:
- Pay down debt: This will free up more money in your monthly budget to make loan payments.
- Increase your income: This could mean getting a raise, finding a new job, or starting a side hustle.
- Get a cosigner: A cosigner is someone who agrees to be responsible for your loan payments if you default. This can help you qualify for a loan even if your DTI is high.
It is important to remember that your DTI is just one factor that lenders will consider when approving you for a loan. Other factors, such as your credit score, employment history, and debt-to-equity ratio, will also be taken into account.
It’s frequently advised that only 50% of your earnings should be allocated to expenses.
However, how can we establish a prudent level of debt?
The 28/36 Rule in lending refers to a widely used guideline that helps financial institutions assess the financial stability of loan applicants.
- Housing Ratio (28%): According to this rule, a maximum of 28% of the borrower’s gross monthly income should be allocated to housing-related expenses. These expenses may include rent or mortgage payments, property taxes, homeowners insurance, and sometimes even homeowner association fees.
- Total Debt Ratio (36%): The rule also specifies that the borrower’s total monthly debt payments, including housing costs as well as other debts like car loans, student loans, and credit card payments, should not exceed 36% of their gross monthly income.
By adhering to the 28/36 Rule, lenders aim to ensure that borrowers have a reasonable balance between their income and financial obligations. This guideline helps prevent borrowers from taking on more debt than they can comfortably manage, promoting responsible borrowing practices and reducing the risk of default.
What is good DTI ratio?
Debt-to-income ratio of 36% or less
With a DTI ratio of 36% or less, you probably have a healthy amount of income each month to put towards investments or savings. Most lenders will see you as a safe bet to afford monthly payments for a new loan or line of credit.
This principle guarantees a well-rounded approach to financial commitments and aligns with the overarching objective of maintaining a robust Expense-to-Income Ratio for borrowers.
