South Africans are some of the most over-indebted consumers in the world. 19.26 million South Africans have skipped debt repayments or defaulted on their credit agreements in some way or another (NCR, Credit Bureau Monitor, 2022). Your DTI will help you to know whether you have too much debt and need assistance in controlling it.
What is Your DTI and How Do You Calculate it?
The debt-to-income ratio (DTI) is calculated by adding up all your debt and dividing this amount by your gross monthly income (your ‘take home’ salary). This amount is then turned into a percentage. The higher the percentage the less likely you are to be granted credit.
Your DTI allows creditors to view whether you can honour your debt repayments, even during financial difficulties. The higher the DTI the more chance that rising costs of living will cause you to default on your debt repayments. This will make you a high-risk candidate. If you do get accepted, be prepared to pay higher interest rates on any credit you apply for.
How Does Your DTI Affect Your Credit Score?
Your DTI does not affect your credit score or even show on your credit report. Some reports may show you a different calculation called a credit utilisation score. This score is calculated by looking at your maximum credit limit and the total debt you owe. For example, if you have a credit card with a limit of R60 000 and your balance on the credit card is R30 000, your credit utilisation score will be 50%.
Consumers with a high credit utilisation will usually have a high debt-to-income ratio as well. This makes them high risk individuals and creditors will rather decline applications or increase the interest rates to deter the consumer from borrowing.
What is The Ideal Range of the DTI Ratio?
There are two parts to your debt-to-income ratio:
Housing ratio or Front-end ratio: This calculation is used to calculate how much of your total ‘take-home’ income is used to cover your housing costs. If you have any insurance on your home this will also be used to calculate this score.
Back-end ratio: This calculation uses all your debt divided by gross income as described above.
The ideal range, therefore, utilises the back-end ratio and the housing ratio and would ideally be lower than 36% for a consumer to be granted credit with favourable interest rates.
How Can You Decrease Your DTI?
There are many ways to decrease your DTI, below are 3 of the best methods:
- Do not take on more debt
The more debt you take on, the higher your DTI score will be. Never borrow money to pay your debt. The interest that you pay on bigger loans does not make sense in the long run. Instead, carefully scrutinise what is needed to take care of the debt you have now and work slowly to decrease it.
- Use a budget or spending planner
Budgeting or planning your spending for the month is key when working towards reaching financial freedom. A budget provides you with the knowledge of where your money is spent and how much you realistically have to work with to pay off your debt faster.
- Make your debt affordable
While you cannot apply for credit while under debt review, your DTI will improve while your debt is paid off in a manageable and affordable manner. Debt review allows you breathing room and a safety net to get rid of your debt once and for all. Get an affordable budget set up by industry experts now and step onto the road to financial empowerment.