If you’re struggling to qualify for a personal loan, your debt-to-income (DTI) ratio could be to blame.
Your DTI, often expressed as a percentage, compares your debt payments with your gross income each month. Loan companies look closely at your DTI before approving your application.
If the ratio is high, lenders take it as a warning sign that you might not be able to repay what you owe. Plus, a high DTI could make it difficult for you to cover living costs or save for the future.
Find out how your DTI can impact not just your loan applications, but also your daily life. Then, consider the six creative strategies for lowering your debt-to-income ratio.
Why does DTI matter?
Let’s say your monthly gross (or pretax) income is $2,000 and you pay $1,000 each month toward your student loans, credit cards, and car payment.
In this example, your DTI comes out to 50%. The Consumer Financial Protection Bureau says borrowers should have a DTI of43% or less to take out a mortgage. A DTI of 50% is considered to be on the high side, so it could prevent you from being able to borrow more money.
Plus, lenders often look for a DTI of 36% or lower for any type of loan. So if your ratio is higher than that, what can you do to bring it down into a more acceptable range?
6 ways you can lower your DTI
Since your DTI compares your monthly debt payments with your income, you need to focus on reducing your debt or increasing your income. Here are six ways to achieve both goals.
- Pay off your loans ahead of schedule
Installment loans typically have a multiyear repayment plan, often with fixed bills from month to month.
But you don’t have to stay on that payment plan. If you can find room in your budget, you could make extra payments to pay off your debt ahead of schedule.
There are a couple of tried-and-true methods to speed up your debt payoff. One is the debt avalanche strategy, under which you first target paying off your high-interest debt while continuing to make minimum payments on other loans.
Another one is the debt snowball method, which involves paying off your smallest debt first and working your way up to your biggest.
Of course, by increasing the monthly amount you pay under either strategy, your DTI could increase temporarily.
But once you get rid of a debt, your DTI should fall to below what it was before you adopted one of the methods — and stay there (unless you take out another loan).
- Target debt with the highest ‘bill-to-balance’ ratio
Besides the debt avalanche and snowball methods, there’s another approach that might be more effective in lowering your DTI. It’s based on the “bill-to-balance” ratio.
“The best strategy is to target the debts which reduce your DTI the most for the least amount of cash paid,” said Eric Bowlin, real estate investor and founder of Ideal REI.
Let’s say you owe $100 on Credit Card A and $50 on Credit Card B. Card A’s monthly payment is $20 and Card B’s is $25.
You would want to target Card B first, since your monthly payment represents 50% of its balance, whereas Card A’s monthly payment only makes up 20%.
As a result, paying off the $50 you owe on Card B would have a larger impact on your DTI than paying off the $100 you owe on Card A.
J.R. Duren, a personal finance writer at consumer review site HighYa, took this approach to qualify for a mortgage. His DTI was a bit too high, so his loan officer suggested he pay off a credit card with a $125 balance.
“While that balance seems really small, the monthly payment was $25, which is significant because it represents 20% of the balance,” said Duren. “Paying off that card freed up enough monthly debt obligations to lower our DTI and make our mortgage possible.”
- Negotiate a higher salary
In addition to lowering your debt, you can change your DTI by increasing your income.
As described in the example above, someone who makes $2,000 each month and pays $1,000 toward loans has a 50% DTI. But if that monthly income increased to $3,000, then the DTI would go down to 33%.
One way of trying to boost your salary (besides changing jobs) is asking your employer for a raise.
“Lay the groundwork for this by taking on extra responsibilities and doing an outstanding job at work,” advised Mark Kantrowitz, the publisher and vice president of research at Savingforcollege.com. “If your employer doesn’t reward your hard work with more money, then start looking for another job.”
When the time is right, rehearse what you’ll say to your boss so that your salary negotiation can be a success.
- Earn extra money with a side hustle
More than 44 million Americans are making extra money with a side hustle, according to Bankrate.
That lets you boost your income each month, thereby reducing your DTI. You also could use the earnings to pay off your credit card balances and loans ahead of schedule.
Although your side hustle will require time and energy, it could bring you closer to a debt-free life.
- Use a balance transfer to lower interest rates
Another strategy for lowering your debt payments is doing a balance transfer.
You could transfer your debt onto a zero-interest credit card using offers with a 0% APR period for a promotional period. Because you don’t have to keep up with interest for a limited time, you could pay off the balance faster.
Watch out for balance transfer fees, though. Also, make sure you can pay off the debt before the promotional period ends and the regular interest rate kicks in. Otherwise, you could end up with higher monthly bills than you started, thereby dragging your DTI down further.
- Refinance your debt with a new lender
If you’re not able to pay off your student loans and other debt ahead of schedule, you could restructure them by refinancing your student loans.
Refinancing can be a great option if you can qualify for a lower interest rate and change your repayment terms. Online lenders such as SoFi and Earnest offer competitive rates to creditworthy borrowers.
You also might be able to lower your monthly payments if you decide to pursue refinancing, which would have a positive effect on your DTI.
Find ways to decrease your debt and increase your income
Your debt-to-income ratio can make or break your application for a loan. Plus, it’s closely connected to your credit utilization, which makes up 30% of your FICO credit score.
A high DTI also is burdensome from month to month, because it means your loan payments are eating up a large portion of your income.
If you see your paycheck disappear toward loans and credit card payments, take steps to reduce your debt and increase your income.
By getting your DTI closer to zero, you can shift your focus to saving money and building wealth for the future.
If you’re concerned about your credit, you can check your three credit reports for free once a year. To track your credit more regularly, Credit.com’s free Credit Report Card is an easy-to-understand breakdown of your credit report information that uses letter grades—plus you get a free credit score updated every 14 days.