How to Reduce DTI Before Applying for a Loan

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If you're about to apply for a loan such as a mortgage, there are a few things you can do to speed up approval and increase your chances of getting a low interest rate. One is to check out your credit score and make improvements if necessary. Another is to reduce your debt-to-income ratio (DTI) before applying.

DTI is a measure of financial health that lenders like to check before agreeing to a loan. By having both a good credit score and a low DTI, you're that much more likely to get approved for a loan.

What Is DTI?

Your debt-to-income ratio compares how much money you pay to creditors each month with how much you earn in that same time frame.

Someone with a high DTI uses a large portion of their income each month to pay their debts. This means they may struggle financially if they borrow more money.

Conversely, someone with a low DTI has a lot of leftover funds after paying what they owe each month. They may easily be able to handle another loan. This is what lenders prefer to see.

DTI is divided into two types: front-end DTI and back-end DTI:

  • Front-end DTI considers payments for housing expenses including a mortgage, homeowners insurance and property taxes.
  • Back-end DTI considers 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.

Different lenders have varying thresholds for both front-end and back-end DTI, so it's important to know which types of debt factor into both.

How to Calculate DTI

DTI is a ratio, or a measurement of what percentage of your income goes toward debt payments. To find your DTI, divide your total monthly debt minimum payments by your monthly gross income (your income before taxes). Then, multiply by 100 to get a percentage.

For example, imagine you make $3,500 a month. Your housing payment is $1,500, and you pay $300 toward your credit card and $100 toward your car payment, for a total of $1,900.

To figure out your DTI, divide $1,900 by $3,500. You'll get 0.54. Multiply this by 100 and you'll see that your DTI is 54%.

Lenders have their own maximum allowable DTIs for different types of loans, so 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 it all depends on how each lender factors in DTI.

How Lenders Use DTI

Lenders use DTI to make decisions on whether to approve a loan and what the size of the loan will be. 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 to pay back a new loan.

Each lender may have its own threshold for what is an acceptable DTI from loan applicants. Lenders want to be confident you'll be able to repay the loan, and a low DTI can show you'll have enough money to take on a new payment.

There are a few generally accepted targets for an ideal DTI, however. As a general rule, mortgage lenders require a DTI under 43%, but may prefer a DTI below 36% on conventional loans. For FHA mortgages and other unconventional home loans, your front-end DTI should be no greater than 31% and the back-end DTI no higher than 43%—though lenders may allow back-end DTIs as high as 50% depending on your credit score.

How to Reduce Your DTI

If your DTI is on the high side, take measures to reduce it before applying for a loan. Try taking a multipronged approach to accomplish this more quickly.

Start with these steps to reduce your DTI:

  • Do pay off existing debt. As you pay off debt such as credit cards, you widen the gap between your total income and your total debt payments.
  • Do boost your income with a new job, pay increase or side hustle. More income will positively affect your DTI.
  • Don't apply for new credit or loans. Even using a new credit card with a low limit can negatively affect your DTI if you start making charges on it.
  • Don't slow down on paying your debt to save for a loan down payment. Instead, pay off debt faster before saving and applying.

Are You Ready for a Loan?

Still wondering if your finances and credit are ready to take on a loan? Your DTI and credit score look at different aspects of your financial health, and addressing both of them will help set you up for success.

If your DTI is too high, high levels of debt may even result in your credit score taking a hit. This is because credit utilization, or the amount of available credit you're using on revolving accounts like credit cards, accounts for as much as 30% of your credit score. When you have a high debt-to-income ratio, you may be utilizing a large amount of your credit.

You can measure your credit utilization by comparing your total revolving credit balances to your total available credit. If your credit balances total $1,000 and your available credit limits total $2,000, your credit utilization rate would be 50%. Experts recommend keeping your utilization rate under 30% overall and with each credit card account.

Keep an eye on your credit score and DTI as you prepare for a loan application. Use these numbers to help you make improvements as necessary, and get the best possible loan offer.

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