The financial market is filled with lenders. This has made it easier for people to take multiple loans from various sources. Every individual has a limit to the amount they can actually repay and going beyond limits will result in bad debt. Lenders want to ensure that the borrower will not default on payments so they use debt to income ratio to calculate creditworthiness. The debt to income ratio, expressed in percentage terms, is an important indicator in ascertaining the ability of an individual to repay a loan. It is used by borrowers to ascertain whether a particular loan applicant is eligible or not. Individuals can also calculate it to see whether they are borrowing within their repaying limits.
It is very easy to calculate debt to income ratio. Any individual with knowledge of elementary mathematics can do it. Here is a step-by-step guide on how to calculate debt to income ratio:
- Calculate your monthly income. Add all income you receive including your salary, income from interests on your investments etc. Those who have a second house or any real estate and earn rent from it should also include it in calculating the net income per month.
- Calculate your monthly loan repayments. Payments for mortgages, car loans, personal loans and credit card payments should be added.
- Now divide the total monthly repayment by total monthly income and multiply it by 100 to arrive at the debt to income ratio.
Example - If your monthly income is $1000 and your monthly loan outstanding is $300 then your debt to income ratio would be $300/$1000= 0.30X100= 30%.
People with debt to income ratio of up to 30 per cent are considered as excellent prospects by lenders. Such borrowers qualify for lowest rate of interests. People with debt to income ratio between 30 to 40 per cent are considered as good prospects whereas those above 40 per cent have to work hard to convince the lenders about their ability to repay the loan. Such people can first repay their small debts and bring down their debt to income ratio before applying for a loan.
You too can calculate the debt to income ratio and keep it as a barometer to ensure that you borrow within limits and don’t fall in a debt trap. Borrow what you can repay and ensure financial well-being, all the time.