If you’re struggling to qualify for a personal loan, your debt-to-income ratio (DTI) could be to blame.
Your DTI, often expressed as a percentage, compares your debt payments with your gross income each month. Loan companies carefully review your DTI before approving your application.
If the ratio is high, lenders take it as a warning sign that you may not be able to repay what you owe. Also, a high DTI could prevent you from covering the cost of living or saving for the future.
Find out how your DTI can impact not just your loan requests, but also your daily life. Next, consider the six creative strategies for lowering your debt ratio.
Why is DTI important?
Let’s say your gross (or pre-tax) monthly income is $ 2,000 and you pay $ 1,000 each month for your student loans, credit cards, and car.
In this example, your DTI comes out at 50%. the Consumer Financial Protection Bureau says borrowers should have a DTI of 43% or less to take out a mortgage. A 50% DTI is considered high, which could prevent you from being able to borrow more money.
Additionally, lenders often look for a DTI of 36% or less for any type of loan. So if your ratio is higher than that, what can you do to bring it back into a more acceptable range?
6 ways to reduce your ITD
Since your DTI compares your monthly debt payments with your income, you should focus on reducing your debt or increasing your income. Here are six ways to achieve both goals.
1. Pay off your loans sooner than expected
Installment loans typically have a multi-year repayment plan, often with fixed monthly bills.
But you don’t have to stick to this payment plan. If you can find room in your budget, you can make additional payments to pay off your debt sooner than you expected.
There are a few proven methods to speed up your debt repayment. The first is the Debt Avalanche Strategy, where you target paying off your high-interest debt first while continuing to make minimum payments on other loans.
Another is the debt snowball method, which involves paying off your smallest debt first and hitting your biggest one.
Of course, by increasing the monthly amount you pay in either strategy, your DTI could temporarily increase.
But once you’ve gotten rid of debt, your DTI should drop below what it was before you adopted any of the methods – and stay there (unless you take out another loan).
2. Target debt with the highest “invoice / balance” ratio
Besides the debt avalanche and snowball methods, there is another approach that may be more effective in reducing your ITD. It is based on the “invoice / balance” ratio.
“The best strategy is to target the debts that reduce your DTI the most for the least money 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. The monthly payment for Card A is $ 20 and that for Card B is $ 25.
You would want to target Card B first, as your monthly payment is 50% of its balance, while Card A’s monthly payment is only 20%.
Therefore, repaying the $ 50 you owe on Card B would have a bigger impact on your DTI than repaying the $ 100 you owe on Card A.
JR Duren, personal finance writer at consumer review site HighYa, took this approach to qualify for a mortgage. Her DTI was a little too high, so her loan officer suggested she pay off a credit card with a balance of $ 125.
“Although this balance seems really low, the monthly payment was $ 25, which is important because it is 20% of the balance,” said Duren. “Paying off that card freed enough monthly debt to lower our DTI and make our mortgage possible.”
3. Negotiate a higher salary
In addition to reducing your debt, you can change your DTI by increasing your income.
As described in the example above, a person who earns $ 2,000 per month and pays $ 1,000 in loans has a DTI of 50%. But if that monthly income increased to $ 3,000, the DTI would drop to 33%.
One way to try to increase your pay (in addition to changing jobs) is to ask your employer for a raise.
“Lay the groundwork for this by taking on additional responsibilities and doing an outstanding job at work,” said Mark Kantrowitz, editor 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 comes, repeat what you say to your boss to make your salary negotiation a success.
4. Earn extra cash with a side scramble
Over 44 Million Americans Make Extra Money With A Side Scramble, according to Bankrate.
There are endless options for scrambling today, from renting a room on Airbnb to driving for Uber to starting an online consulting business.
This allows you to increase your income each month, thereby reducing your DTI. You can also use the income to pay off your credit card balances and loans before they become due.
While your side activity takes time and energy, it could bring you one step closer to a debt-free life.
5. Use a balance transfer to reduce interest rates
Another strategy for reducing your debt repayments is to perform a balance transfer.
You can transfer your debt to an interest-free credit card by using offers with a 0% APR period for a promotional period. Since you don’t have to track interest for a limited time, you may be able to pay off the balance faster.
Beware of balance transfer fees, however. Also make sure you can repay the debt before the end of the promotional period and the normal interest rate. Otherwise, you could end up with higher monthly bills than you started, which would further reduce your DTI.
6. Refinance your debt with a new lender
If you are unable to pay off your student loans and other debts sooner than expected, you can restructure them by refinance your student loans.
Refinancing can be a great option if you can take advantage of a lower interest rate and change your repayment terms. Online lenders such as SoFi and Earnest offer competitive rates to creditworthy borrowers.
You might also be able to lower your monthly payments if you decide to continue refinancing, which would have a positive effect on your DTI.
Find ways to reduce your debt and increase your income
Your debt ratio can make or break your loan application. Plus, it’s closely tied to your credit usage, which accounts for 30% of your FICO credit score.
A high DTI is also a month-to-month burden as it means your loan payments are consuming a large chunk of your income.
If you see your paycheck disappearing towards loans and credit card payments, take steps to reduce your debt and increase your income.
By bringing your DTI closer to zero, you can focus on saving money and building wealth for the future.