There’s nothing like applying for new credit to give you a crash course in financial vocabulary. All of a sudden, terms you’ve never heard before become like a second language — at least until your loan comes through.
One of these terms is “debt-to-income ratio” — how much you owe on debt compared to how much you earn in income. This isn’t something you might think about regularly. But if you’re talking to a lender, then your debt-to-income (DTI) ratio should become top-of-mind.
Read on to find out what your DTI ratio is, why it’s so important, and how to lower it before you apply for that loan.
How to figure out your debt-to-income ratio — and why it matters
Some people conflate DTI with their credit utilization ratio (also called debt-to-credit ratio), but they’re two separate things. Credit utilization ratio is the percentage of how much you owe compared to your credit limits. It also impacts your credit score, which your debt-to-income ratio does not.
You can use our debt-to-income calculator to figure out what your DTI is. Just plug in the numbers and view the results, which will include two versions — a “back-end DTI” which includes all your debt, and a “front-end DTI” which considers just your housing costs. Lenders can look at one or both of these numbers when approving loans.
Debt-to-Income (DTI) Calculator
And if you’re curious as to how to calculate your overall DTI on your own, here’s the formula explained by the Consumer Finance Protection Bureau (CFPB):
- Add up all your monthly debt payments (i.e. mortgage, auto loan, credit card, student loans, personal loans, etc.).
- Add up your gross monthly income.
- Divide between the two.
Here’s a visual from credit reporting bureau Experian as an example:
Experian recommends keeping your total DTI below 43 percent. But if you can go lower, 36 percent and below is even better, as Experian says that’s what most lenders prefer.
How to lower your debt-to-income ratio in 6 steps
If you’ve run the numbers and aren’t happy with what you see, don’t worry. There are things you can do to lower your debt-to-income ratio. In the end, it’s as simple (in theory) as decreasing your debt or increasing your income.
But since those are both easier said than done, here are six suggestions to help:
1. Refinance debt to pay it down faster
Paying down your debt will almost always be the best medicine for invigorating your DTI ratio, and refinancing can be a great way to do that — since the major goal of refinancing is to lower your interest rates. And once your interest rates are lowered, then more of what you pay can go to chipping away at your balance.
If you have credit card debt, one of the most effective ways to refinance is to take on a balance transfer credit card. These cards enable you to have no interest for a limited period, during which you can pay down your debt if you commit to paying more than the minimum.
(Don’t forget, even if you refinance to a lower interest rate, paying only the minimum each month will keep you in debt longer and cost you more money over time. This is especially true with credit cards, since credit card minimum payments only cover one to three percent of your balance.)
People plagued by student loans can refinance as well. There are many refinancing lenders for student loans that can help you obtain lower interest rates and better repayment terms.
But there are two things to keep in mind:
The first is that to stay in line with your goal of reducing debt faster, you might not want to take on a longer debt repayment term unless you plan on paying more than the minimum amount.
The second is that federal loans, once refinanced, turn into private loans. And once that happens, you’ll forfeit your right to utilize federal programs such as loan forgiveness and income-driven repayment plans.
2. Utilize a targeted debt payoff strategy
No matter what you do, utilizing a targeted debt payoff strategy will help you reduce your debt faster, cutting away at the “D” in your DTI.
Here’s what that means: If you’re in the process of paying down debt and you have more than one type of debt, don’t change your monthly payment on your total debt when one debt is paid off.
Instead, take what would have gone to the old debt each month and apply it to another one of your still-current debt accounts — on top of the minimum due. Continue to do this until you’re completely debt-free. And as you go along this route, your debt-to-income ratio will continuously decrease.
3. Redo your budget
Besides setting a targeted debt payoff strategy, you might be able to shift DTI in your favor by redoing your budget.
One possibility is to reconsider the idea of cutting back. If you remove too many line items from your budget, you might find it too restrictive to be sustainable, but what about replacing items with less expensive alternatives? Or reducing the frequency of certain expenses rather than cutting them out entirely?
Another eye-opener in this process can be comparing your actual expenses from the past few months to the budget you already set. Making sure your plans and reality match up can help you set a budget you can feel confident in.
4. Stay on top of your credit report
Even though your debt-to-income ratio doesn’t show up on your credit report, that doesn’t mean your credit report can’t impact it.
You could have errors on your credit report that you weren’t aware of — all it takes is one transposed digit in your social security number for someone else’s loan to show up on your report. Likewise, you might find accounts fraudulently opened in your name.
Such errors could be adding debt that you’re not responsible for to your DTI ratio. To check, you can get a free copy of your credit report each year at AnnualCreditReport.com, a site jointly sponsored by the three top credit reporting agencies.
While you’re at it, take a look at your payment history. This one factor makes up 35 percent of your credit score — and if there are late payments reported that you made on time, you’ll want to ask your lender to fix that and report the proper payment history.
And if you spot an error or see accounts that you didn’t open, immediately dispute it with the credit reporting agency or agencies showing the wrong information.
5. Ask for a raise or overtime hours … or get a new job
Whether you’re an hourly or salary employee, consider what you can do to earn a raise. And if you’re paid by the hour, you could always look into overtime opportunities.
You might not get the result you’d like right away, but starting a conversation with your boss now will help you get on track. And if you’re successful, you might get the income boost you need to improve your DTI ratio (while also having more money to pay down the debt at the same time).
Meanwhile, if you find that you’ve tapped out what you can earn at your current company, consider looking elsewhere. Of course, it’s not always easy to secure a better-paying job, but you might find another company that pays more for the work you’re already doing or which has a better position not available where you work now.
6. Take on a side gig
As long as you’re not working around the clock or inundated with responsibilities at home, then taking on a side gig is a great way to boost your income.
So, what kind of side gigs are there? The list goes on and on. Here are just a few to get the thoughts flowing:
- Love animals? Start pet sitting.
- Interested in a change of scenery? Become a house-sitter.
- Have a special skill? Consider freelancing on the side (as long as it doesn’t present a conflict of interest with your day job).
- Love to drive? Become a Lyft or Uber driver.
- Enjoy being around people? Get a job as a server or bartender.
- Is the mall one of your favorite places? Take on a part-time job in retail.
Be creative and find an opportunity that lines up with your natural interests so you don’t come to resent the extra work. Then, apply all the extra funds to your debt so you can pay it off faster and experience a nice dip in your debt-to-income ratio.
Reducing your debt-to-income ratio has multiple benefits
The great thing about the strategies above is that they can work so well together. And even better, if you work to reduce your debt-to-income ratio, you’ll benefit in more ways than one.
Besides the fact that debt is expensive, certain types of debt can also affect your credit score. More specifically, credit cards and the balances you hold on them contribute to your credit utilization ratio — and that amounts to 30 percent of your score.
And, finally, having a lower debt-to-income ratio and a higher credit score will give you access to less-expensive credit. You’ll not only more likely get approved for credit, but you can get approved at lower rates when you have a higher credit score, as myFico illustrates here:
In other words, lowering your debt now can lower the amount of money that any future debt will cost you. Win-win!
Interested in refinancing student loans?Here are the top 6 lenders of 2018!
|Lender||Variable APR||Eligible Degrees|
|Check out the testimonials and our in-depth reviews!
1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 5.87% APR (with Auto Pay). Variable rate loan rates range from 2.47% APR (with Auto Pay) to 5.87% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of Month/Day/Year, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 08/21/18. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at firstname.lastname@example.org, or call 888-601-2801 for more information on ourstudent loan refinance product.
© 2018 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
Savings example: average savings calculated based on single loans refinanced from 9/2013 to 12/2017 where borrowers’ previous rates were disclosed. Assumes same loan terms for previous and refinanced loans, and payments made to maturity with no prepayments. Actual savings for individual loans vary based on loan balance, interest rates, and other factors.
Application detail: 5 minutes indicates typical time it takes to complete application with applicant information readily available. It does not include time taken to provide underwriting decision or funding of the loan.
Instant rates mean a delivery of personalized rates for those individuals who provide sufficient information to return a rate. For instant rates a soft credit pull will be conducted, which will not affect your credit score. To proceed with an application, a hard credit pull will be required, which may affect your credit score.
Total savings calculated by aggregating individual average savings across total borrower population from 9/2013 to 12/2017. Individual average savings calculation based on single loans refinanced from 9/2013 to 12/2017 where borrowers’ previous rates were provided. Assumes same loan terms for previous and refinanced loans, and payments made to maturity with no prepayments. Actual savings for individual loans vary based on loan balance, interest rates, and other factors.
3 Important Disclosures for SoFi.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.47% – 6.99%3||Undergrad & Graduate|
|2.47% – 5.87%1||Undergrad & Graduate|
|2.47% – 8.03%4||Undergrad & Graduate|
|2.95% – 6.37%2||Undergrad & Graduate|
|2.48% – 6.25%5||Undergrad & Graduate|
|2.72% – 8.32%6||Undergrad & Graduate|