Moneylenders use the debt-to-income ratio as a way to measure an individual’s capability to manage their debt repayments and the payments made each month. This is meant to compare the debt amount you have with your overall income.
Having a good credit score may not guarantee that you will get a personal loan from a bank or other money lending institutions. Banks frequently reject loan applications from individuals whose debt-to-income percentage is high.
Therefore, what is the debt-to-income ratio and why is it so important to a potential borrower.
What Is Debt-To-Income Ratio – DTI
Debt-to-income ratio-DTI isn’t part of a borrower’s credit score. It is instead something that banks and moneylenders use to establish your ability to pay back the personal loan taken. When your debt-to-income percentage is high, bankers in Singapore and moneylenders are likely to turn down your loan application. This is because a high DTI shows that a borrower has a lot of debt for the income they have. This for a lender means you may not be able to manage the repayment of the loans you take out.
The DTI is often expressed using percentages. When you have a debt-to-income ratio of 36% and above, then it means your DTI is high. And the likelihood of your money lender approving your loan application is significantly reduced.
Therefore, you have to work at lowering your debt-to-income ratio ahead of applying for a payday loan. Below are some useful strategies that will help you notably decrease your DTI percentage.
How To Calculate Your Debt-to-Income Ratio?
Step 1: Are you currently paying the mortgage? How about a car loan, personal loan, and monthly credit card payments? Add up all your outstanding debt obligations.
Step 2: Calculate your total monthly income before deductions such as taxes, CPF contributions, and other expenses. You must also include other sources of income, such as commissions, bonuses, or income from your side hustle.
Step 3: Get your DTI ratio. Divide your total monthly debt payments by your monthly gross income. Multiply the result by 100 to get your DTI ratio as a percentage.
You can also use a Debt-to-Income Ratio calculator where you can simply input your income and other financial obligations. The online DTI calculator will do the rest.
What is a Good Debt-To-Income Ratio?
A good debt-to-income (DTI) ratio varies depending on individual financial situations and lending standards. Generally, a lower DTI ratio is considered more favorable, as it indicates that a smaller portion of your income is dedicated to servicing debts. This suggests better financial health and lower risk for lenders.
As a rule of thumb, a DTI ratio of 36% or lower is often considered good. This benchmark is based on the general standards used by many lenders, particularly in the United States.
In Singapore, the Total Debt Servicing Ratio (TDSR) limit should be less than or equal to 55% of your gross monthly income. Maintaining a DTI ratio below this limit can improve your chances of securing a loan in Singapore.
Debt-to-Income Ratio Example
Let’s assume Mr. Park earns a monthly gross income of S$6,000. His monthly debt obligations are as follows:
- Home loan: S$1,800
- Car loan: S$1,000
- Personal loan: S$300
- Credit card debt: S$200
Upon calculating all of his monthly debt payments, he got a total of S$3,300.
To calculate Mr. Park’s DTI ratio:
- DTI Ratio = (Total Monthly Debt Payments / Monthly Gross Income) x 100
- DTI Ratio = (S$3,300 / S$6,000) x 100
- DTI Ratio = 55%
How Lenders View Your DTI Ratio
In Singapore, financial institutions, such as banks, generally do not use the Debt-to-Income (DTI) ratio as a criterion for assessing loan eligibility. Instead, they rely on the Total Debt Servicing Ratio (TDSR) as well as the Mortgage Servicing Ratio (MSR) to determine whether the borrower is a high-risk client.
Lenders will look at the borrower’s TDSR to determine if they are capable of managing their current debt obligations while paying their rent on time, in relation to their gross income. It will also protect borrowers from over-borrowing, resulting in a financial crisis.
DTI is important for various reasons:
- Plays a huge role in a borrower’s eligibility to apply for a loan
- Indicate the borrower’s current financial situation
- Help lenders determine whether the borrower can take on multiple loans
As such, if you have a low DTI or TDSR, you can better qualify for a loan with better terms.
Strategies for Improving DTI Ratio
1. Debt Settlement Plan
When your debt amount is above $10,000, you need to consider debt settlement as a key option for you to decrease the high debt-to-income percentage. When you take on a debt settlement plan, you will be able to give a lump sum of money to your lender. This way you can reduce the actual payday loan amount you owe.
This will also contribute positively to reducing your DTI ratio hence giving potential money lenders confidence in your ability to repay the loan taken thus making them approve your loan applications fast and with ease.
2. Change Repayment Terms
For you to reduce your debt payments for each month, you may do so either by consolidating your debt or by extending the debt repayment plan you had set with your money lender. Having a one-year debt repayment plan will more likely increase your debt repayment installments for each month. On the other hand, a 5-year repayment program will greatly reduce your debt repayment installment for each month.
Even with this new debt repayment plan, you need to realize that by extending the repayment period you will pay more money in the end. But on the bright side, it will do away with any financial strains and stress when repaying your debts thus ensuring you make your monthly installments with ease.
3. Transfer Your Debt Balance
In the debt transfer plan, you can get yourself a credit card which will help you pay one of the smaller debts you owe using the cash advance option. Even though the amount you owe stays the same, your debt instilment for each month is greatly reduced after you have closed one installment account.
4. Increase Your Income
For you to increase your monthly income, you may consider taking a side job. There are many job offers in Singapore today, therefore, do a good search for a job that will not affect your usual 8-5 job schedule. Any employment that increases your income for each month will positively help you do away with your debt easily. It will also help reduce the debt-to-income percentage of your personal finance.
Asking for a pay rise will also increase your income level and it’s also t easier to do. You may also consider turning your hobby into a business, this way you can bring in more money. The goal is to offset all the urgent debt you owe and in turn, reduce your DTI ratio.
5. Lowering Monthly Expenses
Reducing your monthly expenses can help improve your DTI ratio by freeing up more income to cover debt payments. Some ways to lower monthly expenses include:
- Cutting back on discretionary spendings, such as dining out, entertainment, and shopping.
- Reducing or eliminating subscription services, such as streaming services, and gym memberships.
- Refinancing or consolidating existing loans to lower monthly payments.
- Shopping around for better deals on insurance, utilities, and other recurring expenses.
1. Front-End vs. Back-End Ratios
The front-end and back-end ratios are specific types of debt-to-income (DTI) ratios used by lenders, primarily for home loan applications.
- Front-End Ratio: This ratio measures how much of the borrower’s income is used to pay for the mortgage. A typical guideline for an acceptable front-end ratio is around 28%, although this may vary based on the lender.
- Back-End Ratio: This is the percentage of the borrower’s income that is allotted for their total monthly debt obligations, including housing expenses, credit cards, and personal loans. A typical guideline for an acceptable back-end ratio is around 36%. This can also vary depending on the financial institution.
2. What’s the Difference Between Debt-To-Limit and Debt-to-Income Ratios?
The Debt-to-Limit Ratio is also known as the credit utilization ratio. It is a metric used by financial institutions to determine the creditworthiness of a borrower. It divides the borrower’s total outstanding debts by their total credit limit.
A lower debt-to-limit ratio is considered better, as it indicates that you are using a smaller portion of your available credit, which can positively impact your credit score.
On the other hand, the Debt-to-Income Ratio compares an individual’s monthly debt payments to their monthly gross income. As previously mentioned, it is used by financial institutions to determine a borrower’s ability to manage and repay their existing debt.
3. Can My Debt-to-Income Ratio Affect My Credit Score?
Your DTI ratio does not directly affect your credit score, However, it is used by banks and moneylenders to establish your ability to pay back the loan taken. To ensure you qualify for loans easily, there are useful strategies that will help you greatly decrease your DTI percentage.
Calculating your DTI ratio is easy and knowing your ratio can provide valuable insight into your financial health. However, keep in mind that other factors, such as your credit score, credit history, and employment stability, will also play a huge role in determining your eligibility for loans.
- One way of lowering your DTI ratio is by increasing your income either by taking a second job or asking for a pay raise.
- Payment of a lump sum to your debtors will also affect your debt ratio positively.
- The transfer of debt balance will also help reduce your installment accounts to more manageable ones hence strengthening your DTI.
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