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How Does Your Debt-To-Income Ratio Impact Your Business Loan Interest Rate?

Clix November 16, 2021

 

 

Unsecured business loans can be excellent sources of finance if you have been contemplating growth and expansion for your business. You can use a business expansion loan for any business growth-related expenses, like hiring staff, purchasing inventory, upgrading equipment, or expanding workplace. However, lenders look at several conditions while analysing your financial condition and repayment capacity and determine your business loan interest rate. One of the most crucial deciding factors is your debt-to-income ratio. Below you will see how DTI ratio is related to your business loan interest rate.

What is Debt to Income Ratio?

DTI ratio of debt-to-income ratio is the percentage of your monthly income you pay towards debt repayment. Lenders check your DTI ratio to determine your financial health and decide what interest rate to apply to your business loan. If you are already indebted heavily, your DTI ratio will increase, and the lender will perceive you as a high-risk borrower. As a result, they may reject your business loan application or charge a high business loan interest rate.

How Does Your DTI Ratio Affect Your Business Loan Interest Rate?

Depending on your DTI ratio, lenders get a clear picture of your existing debt. Based on that, they think about your future loan prospects and determine how much loan amount you can handle conveniently. If you have a high DTI ratio, the lenders may offer you a low loan amount at high interest rate. A high DTI ratio also reduces your credit score, which the lenders look at while determining your business loan eligibility.

When you apply for a business loan, lenders depend on your DTI ratio to determine your creditworthiness and repayment capacity. Since unsecured business loans are collateral-free, they are high-risk endeavours for the lenders, and they refrain from approving loans for borrowers who are already heavily indebted.

How Lenders Calculate Your DTI Ratio?

As mentioned earlier and as its name suggests, your debt-to-income ratio is the percentage of your monthly debt as compared to your monthly income. The formula to calculate your DTI ratio is

DTI Ratio = Total Debt Payments Every Month​ / Your Total Monthly Income

Your total debt payments include all the debt payments you make in a month, including all your loan EMIs and credit card bills. Your total monthly income consists of the money you get in hand after all your tax deductions. Using this formula, lenders calculate your DTI ratio to offer you a business loan interest rate according to your repayment capacity.

After calculating your DTI ratio, the lender will determine whether you fall in the high-risk zone or the low-risk zone. Once they determine your financial condition, they will approve or reject your loan application and offer you a favourable interest rate. Ideally, if your DTI ratio is less than 30-40%, lenders consider you as a low-risk borrower and charge a lower interest rate from you. On the contrary, if your DTI ratio is more than 40%, you may need to pay a higher business loan interest rate.

Therefore, if possible, try to pay off your existing loans before applying for a business expansion loan. Doing this will reduce your DTI ratio and increase your chances of getting a loan at favourable interest rates.

Tips to Reduce Your Debt-to-Income Ratio

Since having a low DTI ratio results in a lower business loan interest rate, you may follow these steps to minimise it before applying for a business loan:

    • First of all, you must find ways to increase your income. Since your DTI ratio is directly related to your income, it can reduce if you increase your earnings. While applying for a business expansion loan, mention all your income sources, including interest and rent. Also, focus on your business operations to increase your income and profit.
    • If you have several loans to address, avoid applying for more loans from the lenders. Pay off your existing loans first and then apply for the lowest loan amount you can repay easily.
    • Make a list of all the debt payments you make every month and identify those with the highest monthly EMIs. Make a plan to pay them off first. Doing this will reduce your DTI ratio and also save money on the interest outgo.
    • If paying off debts is not possible, try to reduce their interest amount with ways like debt consolidation and balance transfer. You may also consider refinancing your existing loans to get a better interest rate and reduce your DTI ratio.
    • Extending the loan tenure for your existing loans may decrease your monthly loan burden. You may end up paying a higher interest outgo by choosing a longer loan tenure, but the benefit you get will be worth it.
    • Avoid adding to your existing debt by keeping your non-essential expenses under control. Doing this will reduce your DTI ratio in the long run, as you can pay more of your principal amount rather than the interest amount.
    • Consider debt consolidation, as it is an excellent way to reduce your interest rate and make your loans more manageable. You may use the money you save to pay off your existing loans or credit card bills, which will eventually reduce your DTI ratio and reduce your business loan interest rate.

You would need a business expansion loan at different stages of your business. However, you can make the most of it only if you get a loan offer with a favourable business loan interest rate. Since the DTI ratio is one of the most crucial factors determining your interest rate, try to reduce it using the tips mentioned above. Finally, get in touch with Clix Capital to apply for a business loan of ₹ 5 to 50 lakhs. Use your loan amount to expand your business and make the most out of it by availing minimum possible interest rate.

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