Deciding to apply for a loan is easy, especially when you are in dire need of money. But this is not the only thing that banks will look into. Banks and lenders do not approve loans right away. They need documents and proof to find out if you have the capacity to repay the loan. Along with these, the bank or lender will also compute your debt-to-income ratio.
Debt-to-Income Ratio Defined
Also called the debt ratio, the debt-to-income ratio is a metric used to know a borrower’s capacity to repay a loan. Lenders use this to see if you are in a good financial position to apply for a loan. Lenders will use a percentage from your income to compute the ratio. If the ratio they have obtained from your income is high, there is a big chance of loan rejection.
The banks and lenders would want to ensure that you will still have a good amount of money left from your income after paying for the loan. A debt-to-income ratio is a good tool for borrowers since it helps them know how much money they will still have after paying for their debts.
Knowing the debt ratio will help borrowers decide whether they will still push through with the loan. There are instances when a borrower learns that they get approval for the loan. Yet, after knowing their debt ratio, they back out because the amount that they get is not enough for their needs. This is why it is essential to know the ratio before pushing through with the loan.
How Does the Debt-to-Income Ratio Work?
You may have come across this term when you applied for a loan. Oftentimes, borrowers do not pay much attention to it. It is because they only want to know whether their loan application gets approved or not. When asked to fill out a loan application form, you will put in information about your income and the amount you spend monthly. These are the details needed to compute the debt-to-income ratio.
The lender or bank will do the computation. If you obtained a ratio above 100%, it means that you will owe more than what you earn. Lenders and banks would want to see a ratio way below 100% to approve the loan.
What Debt-to-Income Ratio is Acceptable?
The most acceptable ratio is 0%. This implies that you do not have any debts and have the full capability to pay for a loan. Yet, this is not always the situation for many people. So, what ratio is acceptable to get a loan approved?
If you have obtained a ratio of 35% or below, you are in the safe zone. This means that you can keep an amount that can cover your needs. After paying for your debts, the amount left for you is enough or even more than what you need for your payables monthly.
This ratio puts you in the middle of whether you can or cannot have the loan approved. It means that you could have enough money left in your wallet once you pay your debts but might be enough for your monthly needs. When this happens, the lender or bank will weigh in and consider other factors to determine whether you are worthy of the loan or not.
This ratio gives you a warning that you are in the danger zone. When half of your income goes to your debts, there is little chance to prove that you can still pay for another loan. This is because you still have needs and payables to shoulder monthly. With this ratio, your loan application gets rejected.
To sum things up, the fewer debts you have, the lower the debt-to-income ratio you can get. With this, your loan application gets approval in a breeze. If you need to borrow money, you first need to work on increasing your income and paying off existing debts. This way, your ratio can increase.
If you feel confused about how to make your debt ratio work to your advantage, you can consult a debt or credit trustee. These professionals can help you learn more about managing debts and give you a plan so you can straighten out your financial status. Once you have achieved a healthier financial situation, you’d get more chances of getting loan applications approved.