How to Lower Your Debt-to-Income Ratio Before Applying for a Loan

What Is DTI?

DTI is expressed as a percentage that compares how much money you pay to creditors each month with how much you earn in that same time frame. A borrower with a high DTI uses a large portion of their income to pay their debts. Conversely, a borrower with a low DTI has ample funds left over after paying what they owe each month. As a result, they're more easily able to handle another loan payment—which is what lenders prefer to see.

DTI is divided into two types: front-end DTI and back-end DTI. Requirements for each vary by lender and loan type, and front-end DTI will typically only come into play when you apply for a mortgage.

• Front-end DTI: This compares your income with your payments for housing expenses only, including those for a mortgage, homeowners insurance and property taxes.
• Back-end DTI: A more comprehensive measure of your finances, back-end DTI compares your income with all debt payments, including housing expenses. This might include student loan, credit card and car payments, but does not include regular living expenses like transportation costs and food.

What Is a Good Debt-to-Income Ratio?

A good DTI varies depending on the type of loan you're applying for, but lower is better. In general, aim for a DTI below 50%.

If you're seeking a mortgage, the requirements are often more rigorous. Lenders of conventional loans commonly like to see a front-end DTI of less than 28% and back-end DTI of less than 36%, depending on the type of loan. But you may be able to qualify with a DTI of up to 45% or 50% if you have significant cash reserves or a good credit score.

How to Calculate Debt-to-Income Ratio

To calculate your DTI, add up your monthly debt payments—using your minimum payment in the case of credit cards—and divide it by your monthly pretax income. Then multiply that number by 100 to come to a percentage.

Example: Let's say your gross income is $3,500 a month. Your housing payment is $1,500, and you pay $300 toward your student loans and $100 toward your car loan, for a total of $1,900. To determine your DTI, divide $1,900 by $3,500; you'll get 0.54. Multiply this by 100 and you'll come to a DTI of 54%.

Lenders have their own maximum allowable DTIs for different types of loans. Knowing your DTI before applying for a loan can help you prepare and get approved. For many lenders, particularly mortgage lenders, a DTI of 54% may be too high to issue a loan. But the way lenders factor DTI into their decisions can vary—and can be influenced by other elements of your application, such as your credit score and available cash reserves.

How Lenders Use DTI

Lenders use DTI to decide whether to approve a loan and how large of a loan to offer. Your credit score tells lenders how you've managed loan payments in the past, but your DTI tells lenders if you have enough money available now to afford a new loan payment.

Each lender may have its own threshold for an acceptable DTI. But overall, lenders want to be confident you'll be able to repay the loan, and a low DTI shows that there's less risk that you won't repay the loan as agreed.

How to Lower Your Debt-to-Income Ratio

If your DTI is on the high side, take measures to reduce it before applying for a loan. Start with these steps:

1. Pay Off Existing Debt

As you pay off debt such as credit cards, student loans, car loans and personal loans, you widen the gap between your total income and your total debt payments. Consider using the debt snowball or debt avalanche strategies to send more money toward debt payments, and make a budget if you'd like to make more of your income available for debt paydown.

2. Boost Your Income

Consider asking for a raise, opting for a higher-paid job or adding on part-time or gig work. More income will positively affect your DTI, and if you can pay down more debt while earning a higher income, your DTI will decrease even faster.

3. Avoid Applying for New Credit Cards or Loans

Steer clear of new debt, including new installment loans and credit cards. Even using a new credit card with a low credit limit can negatively affect your DTI if you start making charges on it.

4. Pause or Reduce Down Payment Savings if Necessary

If you're working toward applying for a mortgage, it can be difficult to know which to prioritize: strengthening your down payment or reducing DTI. Because DTI can significantly affect your approval odds, don't slow down debt payoff to save for a large down payment. Instead, focus on reducing debt first so that you're in the best position possible to get a mortgage.

Refinancing loans and consolidating debts into a new, lower monthly payment can both reduce your DTI. But they also require applying for and taking on new credit, which may be a red flag for the lenders you're hoping to wow with your lower DTI.

The Bottom Line

DTI is a considerable factor in whether you'll get approved for a loan, especially a mortgage. Reducing your DTI is a meaningful way to prepare for a loan application, and while it may take more time than you'd like, it has multiple positive effects on your finances.

Lower debt means less stress and, likely, a higher credit score as your amounts owed and credit utilization rate both decrease. Along with a better chance at the car loan, mortgage or other loan you've been eyeing, those benefits make lowering your DTI a worthwhile part of your financial plan.