September 25, 2015

Are you thinking of buying a house sometime soon? Or, are you planning to take a vacation abroad? Well, if you are thinking of doing either, and planning to obtain a loan, you got to know whether you can meet your monthly repayments.

Debt-to-income (DTI) ratio will assist you to understand your financial position so that you know whether or not you would qualify for a loan for your mortgage or a trip.

Your DTI ratio is a valuable number that shows how much of your income/money is dedicated to monthly financial repayments. This ratio is used to determine your level of risk as a borrower

Why is DTI ratio important?

The DTI ratio is important because it shows the credit provider (and to you) your ability to repay your loans without facing any difficulties. DTI ratio will assist you to understand your financial

Well-being,that is your income/money earned compared to the amount of money that you owe to credit providers.

DTI ratio is the financial benchmark many experts use to help you decide how much debt is too much where the ability to manage the repayments every month becomes too difficult or impossible. 

So how do I know what my DTI ratio is?

Credit providers will calculate your DTI ratio when you are applying for a loan. However, it is advisable that you do this yourself before going to the financial institutions or credit providers. The ratio is calculated using a simple formula:

How to calculate DTI ratio?

DTI ratio:  (total monthly debt payments) / (totalnet income per month) ×100

Take the total amount of money you are spending on repaying your debts, divide that by your total net income and multiply the result by 100. The final figure should be taken as a percentage.

Case Study

Samu is already paying$200 permonth for his home loan and $50 to a hire purchase company. So, his total fixed debt repayment permonth is $250 ($200 + $50). Samu’snet income is $500 per fortnight or $1,000 a month. His DTI ratio would then be ($250 ÷ $1,000) x 100 = 25%.  Hence, his DTI is 25%.

What does this mean?

This means that 25 cents out of every dollar that Samu earns, goes towardsrepaying his debts.The remaining 75% of his pay is available for him to use on living expenses or to even obtain a new loan. It is important to take into account the daily living expenses that must be met from this remaining 75%.

Another example is of John, who pays $1,000 each month for his home loan, $600 for his car loan and $400 to the hire purchase company each month, so his total monthly debt is $2,000 ($1,000 + $600 + $400). If John’s take home monthly income is $3,800, his DTI would be $2,000 ÷ $3,800 =53%. John still has the rest of 47 per cent of his monthly income to cater for his and his family’s day to day living expenses (i.e. bus fares, food, water and electricity bills, fuel, entertainment etc.).  Should John take more loan?

How to know whether you are in the safe zone?

A low debt-to-income ratio shows there is a good balance between your debts and your income. However, a high DTI ratio means your debt levels are high in relation to what you earn and therefore, you could have trouble with your repayments. The recommended 30% to 40% is considered to be within the safe zone to pay your monthly repayments. Taking more loan with DTI ratio of more than 40% means you can run into trouble if you are not careful in managing your living expenses. In John’s case, he will take a big risk if he decides to borrow more when his DTI ratio is 53%.

In general, the lower the number, the better the chance you will be able to get the loan or line of credit you want.

How often should I calculate my DTI ratio?

You can calculate your DTI regularly to check your financial status. And, if you intend to take more loans then a DTI ratio calculation is a must.