Thirty-two-year-old Mihir Shankar had just got engaged. He planned to buy a Rs 50-lakh house he had his eyes on and had enough money saved to make a down payment for the property. He had also applied for a home loan and was waiting for it to be approved. Shankar was confident that the loan would be sanctioned as he had a high credit score of 824. But, he was left shocked when his loan application was rejected. Why did this happen?
When evaluating the financial fitness of a loan applicant, besides a good credit score, banks also look at the applicant’s ability to pay off additional debt. This is where Shankar’s problem was. He has other liabilities in the form of a student loan and an auto loan. The score by the Credit Information Bureau (India) or CIBIL reflects how the earlier loans taken by a person were serviced. It does not say anything about his ability to service more loans.
The debt-to-income ratio (DTI), on the other hand, measures a person’s ability to manage debt repayments. It is calculated by dividing a person’s total monthly debt obligations, such as minimum credit card payments, auto loan, student loan, etc, by his net monthly income. The DTI ratio helps lenders evaluate the additional debt an applicant can handle. A low DTI shows you have a good balance between debt and income. Most banks usually go by a DTI of 40% as a threshold limit for sanctioning loans.
Shankar can still buy the house, if his fiancé is able to take a loan. However, he cannot be a co-applicant or even a guarantor for the loan as the DTI will come in the way. Instead, he should focus on reducing his overall debt burden, by utilising any lump sum cash inflows towards clearing his existing loans. This will improve his borrowing power and also help him manage his financial situation better. The lower the DTI, the more appealing he will be to the lenders.
(Courtesy Centre for Investment Education and Learning (CIEL))
When evaluating the financial fitness of a loan applicant, besides a good credit score, banks also look at the applicant’s ability to pay off additional debt. This is where Shankar’s problem was. He has other liabilities in the form of a student loan and an auto loan. The score by the Credit Information Bureau (India) or CIBIL reflects how the earlier loans taken by a person were serviced. It does not say anything about his ability to service more loans.
The debt-to-income ratio (DTI), on the other hand, measures a person’s ability to manage debt repayments. It is calculated by dividing a person’s total monthly debt obligations, such as minimum credit card payments, auto loan, student loan, etc, by his net monthly income. The DTI ratio helps lenders evaluate the additional debt an applicant can handle. A low DTI shows you have a good balance between debt and income. Most banks usually go by a DTI of 40% as a threshold limit for sanctioning loans.
Shankar can still buy the house, if his fiancé is able to take a loan. However, he cannot be a co-applicant or even a guarantor for the loan as the DTI will come in the way. Instead, he should focus on reducing his overall debt burden, by utilising any lump sum cash inflows towards clearing his existing loans. This will improve his borrowing power and also help him manage his financial situation better. The lower the DTI, the more appealing he will be to the lenders.
(Courtesy Centre for Investment Education and Learning (CIEL))
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