An Overview Of The Debt To Income Ratio And Its Significance


Are you planning to avail a loan or mortgage? In those instances, you will give utmost importance on your credit score as it is one of the major factors that determines your trustworthiness as a borrower. However, another term that holds equal importance in those instances, but slips out of the focus is the Debt-to-income ratio. Remember, this ratio is one of the major factors that determines the credit score of an individual and hence, you should give equal importance on this aspect as well.

what is debt-to-income ratio and how to calculate it?

Before going deeper into the importance of this point, it will make sense to discuss the meaning of the terminology. Put in simple terms, this is the ratio between your perpetual liabilities and your gross income, before the computation of the tax.

However, you would need to keep in mind that your perpetual liabilities will include all those payments, payable towards the repayment of the existing debt as well as the fixed costs that you have to incur at fixed intervals, usually on a monthly basis. Thus, this will include the liabilities for the payment of utility bills as well. Hence, you can say that it will be the ratio between all the ongoing expenses and the gross monthly income. This ratio will determine the amount that you will have in your hand after you make the payments for the existing liabilities.

The calculation of this ratio is extremely simple and you will require dividing your overall monthly liabilities for the payment of existing debts, fixed expenses by your monthly gross income. You can use the Debt to income calculator to determine the ratio, instantly.

Why lenders give importance to this ratio, while processing the application for loan and mortgage?

From the discussion made above, it comes up why the financiers give so much importance on the aspect of the Debt-to-income ratio, while processing the applications for mortgages and loans. Lenders basically stake money, lending out the fund to the borrowers. Hence, they consider the repayment capacities of the applicants so that they don’t feel it tough to manage the repayment and thus, the financiers can escape the instances of bad debt.

As this ratio suggests the amount that an individual will have in hand, after paying the existing liabilities as the repayment towards the existing loans, mortgages as well as the paying the perpetual expenses like power utility bills or the payment of the rents. Thus, this will be the actual amount that the applicant can actually use to make the repayment of the new loans and mortgages.

As a matter of fact, this index is used by the credit rating agencies, in addition to the financiers, to evaluate the creditworthiness of an individual. Thus, if you have to bring improvements in your credit score, you should try to lessen the ratio between the debt or the existing fixed costs and the monthly gross income. As the monthly income does not enhance regularly, it is important that you reduce the fixed costs and expenses to the extent possible. You should take help of the Debt to income calculator to determine your score.

What are the available benefits in having a formidable debt-to-income ratio?

If you have a lower debt-to-income ratio, you can reap manifold benefits. For instance, if you are among these flocks and when you make application for any loans or mortgages, you will not only have higher chances of getting the approval of your application, but you can expect to get funding of higher amount. Likewise, you will appear more reliable to the financiers and hence, they are likely to charge you a lesser rate of interest. Most importantly, as this ratio drops down, the credit score will rise in turn, and hence, you can, additionally, avail rebates in the rate of the premium payable on the insurance policies. Thus, you need to take all the necessary measures that will bring down the ratio to the maximum extent possible.

You should focus on keeping the fixed cost as low as possible. For those expenses which you inevitably have to pay, you should ensure that you are paying without default so that the credit score gets to a better standing.

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