Picture this, after years of hard work and careful consideration, you finally decide to buy a home. And so, you apply for a home loan, but it gets delayed. What went wrong? Your credit score was impressive, so what was the issue?
Perhaps your debt-to-income ratio was the issue. Just like your credit score, a debt-to-income ratio is an important criterion that lenders follow to decide if they should approve your home loan application.
Let’s learn more about the debt-to-income ratio and how it is a silent factor in your home loan success.
What is the Debt-to-income Ratio and Why it Matters?
A debt-to-income ratio is a key metric carefully considered by lenders to approve or reject loan applications. It is the percentage of debt that a person has acquired as opposed to their income. The metric helps establish if the borrower is already living on debt. The metric gives a lender a fair idea of the financial capabilities of the potential borrower to pay off their home loan.
You can arrive at this ratio by dividing your monthly debts by your monthly payments.
Let’s say you have an average monthly credit card bill of INR 25,000 and a car loan of INR 15,000. Your monthly income is INR 1,00,000.
The total debt you have is INR 40,000
To calculate the Debt-to-Income ratio – 40,000/ 1,00,000 x 100 = 40%
A debt-to-ratio metric is an indicator of a financial position. Ideally, the less debt you have, the more financially capable you are in the eyes of the lender.
A debt-to-income ratio of 40% means that you are not doing badly, but you can do a little better.
What Does a Particular Metric Signify?
The number above was just an illustration. Your debt-to-income score will vary. Here’s what your debt-income-ratio will signify:
Case 1: The Debt-to-income Ratio is <35%
As we said, the lower the debt you have, the better you are doing financially. A Debt-to-income ratio lower than 35% means that you are depending less on credit and more on your personal funds.
You are more likely to get your home loan approved in this case.
Case 2: The Debt-to-income Ratio is Between 36-49%
This Debt-to-income ratio means that you are doing good but you must make some improvements. This may include controlling your credit card expenses. You might as well begin using a debit card to reduce your debt.
A lender may doubt your creditworthiness a little with this score. So, you must do the needful to improve the ratio and increase your chances of getting your home loan approved.
Case 3: Your Debt-to-income Ratio is >50%
If you have a debt-to-income ratio of more than 50%, you are in the red zone. This means you are depending excessively on credit. It may also mean that you are not financially capable of managing your expenses and hence are relying on credit to fund your lifestyle.
This score will make it difficult for you to get your home loan approved. In this case, you must take the essential steps towards decreasing your reliance on credit and increasing your income, be it by active or passive means.
What if your Debt-to-income Ratio is Poor but Your Credit Score is Impressive?
A debt-to-income ratio and credit score are two different concepts, but equally important when it comes to determining your home loan eligibility. While a credit score evaluates how you handle your credit, a debt-to-income ratio evaluates how much you are relying on credit.
You may be paying your loans and bills on time, but it doesn’t change the fact that you are relying on credit than your own resources for your financial requirements. You may be doing so out of habit or because your income is insufficient to meet your lifestyle.
Whatever the case is, you will still be considered a risky borrower by the financial service provider approving your home loan. Remember, a home loan is a massive debt for the borrower. This debt, when supplemented with other debts, would only create financial catastrophes that the borrower may not be able to deal with.
Empower Your Finances for Homeownership
Now you know why credit score and a debt-to-income ratio affect your home loan applications. They also reflect your financial standing and can be considered a wake-up call. So, if you want to get that home loan approved or lead a financially comfortable life, you need to develop a much more financially responsible approach and disciplined credit behaviour. Improving both these scores may be difficult, but not challenging. Just get started, stick with the good financial habits and you will just do fine.
When you are ready to secure a home loan, make sure you choose one of the best and most reliable financial service providers in the market. One such example is Tata Capital. It has been renowned for its authentic and quality financial products and services for decades now. So, go ahead, visit their website and explore a vast variety of loan options!
