Debt to income ratio
Also written DTI · Debt to income ratio (DTI) · Debt servicing ratio
Monthly debt servicing commitment divided by monthly income — the ratio that says whether a household's income can carry the loans it already has, let alone another one.
In plain language
A household can look wealthy on paper and still be one missed bonus away from trouble. The leverage ratio measures how much debt went into acquiring the assets; it says nothing about whether the income arriving each month can actually service that debt.
Debt to income ratio asks the cash flow question instead: of every rupee that comes in, how much is already promised to a lender before anything is spent or saved? It is the parameter lenders themselves use to decide eligibility for an additional loan, which is why an adviser should compute it before the client applies and is refused.
How it works
Debt servicing means all payments due to lenders, principal and interest alike. Every EMI, every card payment, every instalment.
A ratio higher than 35% to 40% is seen as excessive. At that level a large part of the household income is committed before regular expenses and savings are met; borrowing in an emergency becomes difficult; and any reduction in income puts the household's finances under stress.
There is no perfect or optimal DTI that lenders require. All lenders agree that lower is better, and each sets its own limit depending on the size and type of loan it is issuing. Like the other personal finance ratios, DTI should be computed periodically — say once a year — and compared with the household's own past numbers to reveal the trend, rather than read once against a textbook benchmark.
The formula
Debt to income ratio = Monthly debt servicing commitment ÷ Monthly income
where debt servicing = all payments due to lenders, whether principal or interest.
A worked example
The workbook gives two cases. An individual earning Rs 1,50,000 a month with loan commitments of Rs 60,000 a month has a DTI of 60,000 ÷ 1,50,000 = 40% — at the edge. A salaried employee drawing Rs 15,000 a month and paying Rs 7,500 towards debt servicing is at 50%, which is too high: half the income is gone before groceries, emergencies or investing.
Now a full household. Mr Menon takes home Rs 1,80,000 a month.
| Borrowing | Monthly outgo |
|---|---|
| Home loan EMI | Rs 52,000 |
| Car loan EMI | Rs 18,000 |
| Personal loan EMI | Rs 21,000 |
| Credit card payment | Rs 6,000 |
| Total debt servicing | Rs 97,000 |
DTI = 97,000 ÷ 1,80,000 = 53.9% — far past the 35–40% mark.
He wants a Rs 25 lakh top-up loan whose EMI would be Rs 23,000. That takes debt servicing to Rs 1,20,000 and DTI to 66.7%. No sensible lender approves it, and an adviser should not want them to.
What actually works is the workbook's own rescheduling rule — rank debt by cost and clear the costliest first. Retiring the personal loan and the card removes Rs 27,000 of monthly outgo:
DTI = 70,000 ÷ 1,80,000 = 38.9% ← back inside the band
And the stress test nobody runs: if Mr Menon's income falls 20% to Rs 1,44,000, the same Rs 97,000 of EMIs becomes a DTI of 67.4% without his borrowing one more rupee.
Why NISM asks about it
Chapter 3 (Cash Flow Management and Budgeting), section 3.9.10, introduces DTI among the personal finance ratios; Chapter 4 (Debt Management and Loans), section 4.2, uses it as the indicator of how much debt a household can take on and as the input to the loan tenor decision. Numeric questions hand you an income and a set of EMIs. Conceptual ones ask which ratio measures the ability of income to service debt — DTI — as against the extent of debt used in acquiring assets, which is the leverage ratio.
Common exam traps
- The denominator is income, not surplus. Subtract living expenses first and you have computed a different ratio.
- The numerator is debt servicing — principal plus interest, not interest alone, and it includes every lender, card companies included.
- 35% to 40% is a benchmark, not a rule. The workbook is explicit that there is no perfect or optimal DTI and that each lender sets its own limit by loan size and type.
- Do not confuse it with the leverage ratio. Leverage is a balance-sheet measure of debt used in asset acquisition; DTI is a cash-flow measure of servicing capacity. The exam puts both in the options.
- A DTI inside the band is not proof of safety. Recompute it at a 20% lower income — that is the scenario the household will actually meet.
- Benchmarks are customised. Compare the household with its own numbers from last year before comparing it with a textbook.
Where this is taught
Free preparation for NISM Series XVIIRelated terms
- Credit scoreThe number a credit information company builds from your loan and credit-card repayment history, and the first thing a lender looks at when your application arrives.
- Debt trapThe state a borrower reaches once debt is being used to meet ordinary living expenses, so fresh borrowing becomes necessary to service the borrowing already outstanding.
- Debt servicingAll payments a borrower owes a lender, whether principal or interest — the actual monthly outflow that every EMI, card payment and instalment adds up to, before it is turned into any ratio.
- Emergency fundA pool of money held in liquid assets, sized at six months of household expenses, kept aside so that an interruption in income does not force the sale of long-term investments.
- Leverage ratioTotal liabilities divided by total assets — the personal finance ratio that measures how much of a household's asset build-up was paid for with debt.
- Liquidity ratioLiquid assets divided by monthly expenses including loan repayments — the number of months a household could keep paying its bills from short-term assets if income stopped.
- LeveragingUsing borrowed funds rather than own funds to buy an asset — it can raise the return on the investment, and it magnifies the loss by the same mechanism.
- BudgetingListing and itemising a household's income and expenses — mandatory, essential and discretionary — to keep spending within income and generate a targeted amount of savings for goals.
- Expenses ratioAnnual recurring expenses divided by annual income — the share of a household's earnings consumed by regular living costs, and the exact mirror of the savings ratio.
- AmortisationThe repayment of borrowed capital over a fixed term through equal instalments, each of which is split between interest and principal in proportions that shift over the life of the loan.
- Credit Information CompanyAn RBI-licensed company that collects borrowers' repayment records from lenders, stores them, and supplies credit information reports and credit scores to specified users.
- Snowball strategyA debt repayment strategy that clears the smallest outstanding loan first and rolls the freed-up payment into the next, ignoring interest rates — used mainly for motivation.
- Pre-EMI interestInterest-only monthly payments on a loan that has not yet been fully disbursed — typical of home loans for under-construction property — before full EMIs of principal and interest begin.
- RestA lender's interest-charging cycle — how often the outstanding loan is recomputed for interest — which can differ from the repayment cycle and raise the true cost of a loan.
- Cash flow mismatchA timing gap in which money going out falls due before money coming in arrives — so a household that earns more than it spends can still run short of cash and be pushed into costly borrowing.
- Debt reschedulingA change to the terms of an existing loan — a lower EMI, a longer tenor, or a lower rate — agreed with the lender when a borrower can no longer service it as originally structured.
- Financial assets ratioThe share of an investor's total assets held in financial form — shares, deposits, mutual funds — rather than physical form such as gold or real estate, expressed as a percentage.