Why it is good to have a low Debt-to-Income Ratio 

5 MinsJan 19, 2022

Today, you can easily avail of a loan for almost any need. Hence, a loan is not just a debt you have to repay but more a tool to help you achieve your goal. Provided, you manage your loan sensibly and repay diligently on time. That is why you need to pay close attention to your Debt-to-Income ratio and keep it in check. 

what is a good debt to income ratio

What Is Debt-to-Income Ratio?
The Debt-to-Income ratio reveals monthly debt obligations vis-à-vis the Net Take Home (NTH) pay and is expressed in percentage terms:

what is a good debt to income ratio

When you compute your Total Monthly Debt Payment or debt obligations, you must consider all the EMIs on your loans – be it a Personal Loan, Car Loan, Home Loan, Education Loan, Business Loan, Credit Card dues, etc.

Similarly, to compute your Net Monthly Income, you should account for the actual income you earn from various sources: salary, business or profession, house property, capital gains, and other sources (interest, dividend, etc.). 

So, say you are drawing an actual monthly income of Rs 2 lakh per month from all sources, but against that, your total monthly debt obligation is Rs 95,000; it means that your Debt-to-Income ratio is 45%. 

Ideal Debt-to-Income ratio
Ideally, as a thumb rule, your Debt-to-Income ratio should not exceed 40% of your net monthly income or Net Take Home pay. When your Debt-to-Income ratio crosses this level, it should be a constant endeavour to bring it down to a reasonable level. 

Also read: 5 factors that affect your personal loan interest rate

How to lower your Debt-to-Income ratio?

  • If you have received a windfall income, utilise it. This could be an annual increment or a performance bonus.
  • If there is an investment avenue that is not offering optimum returns, you could consider redeeming it and using the funds to repay your loan partly or fully 
  • You could find ways to raise your income for instance, by renting out your second house property, finding a part-time job, monetising hobbies, etc, 
  • You could reduce the number of loans by taking a low-interest personal loan and repaying all other loans. This is called debt consolidation. This way you can save your hard-earned money from high-interest outgoings and clear your debts sooner. 

For example, when you have outstanding credit cards dues, attracting a very high rate of interest (say around 40% per annum), plus have an existing high-interest personal loan; in such a case, it would make sense to consolidate such loans into one Personal Loan from a bank offering a competitive interest rate and other agreeable terms and conditions. Axis Bank, for instance, now offers Personal Loans starting at an interest rate of 10.25% p.a.

How does a lower Debt-to-Income ratio help? 

A high Debt-to-Income ratio if it is high may have a bearing on your financial health. 

  • If your Debt-to-Income ratio is high (over 55%), it will reduce your chances of securing a loan. Even if you do get the loan, it may not be at the best terms and conditions. 
  • A high debt-to-income ratio limits your ability to save and invest. It may get in the way of accomplishing vital financial goals, viz. your child’s future needs and your retirement. 
  • If you miss any of your loan repayments due to too much debt, it will impact your creditworthiness and pull down your credit score. You may have to pay a penalty or even face legal action from the lender, in the worst-case scenario.

Axis Bank offers Personal Loans at competitive rates. Transferring your existing loans to Axis Bank could potentially lower your debt burden and help lower your Debt-to-Income ratio. 

Disclaimer: This article has been authored by PersonalFN, a Mumbai based Financial Planning and Mutual Fund research firm. Axis Bank doesn't influence any views of the author in any way. Axis Bank & PersonalFN shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision