Understanding This Pesky Ratio That’s Crucial for Loan Approval
You’ve probably heard the term “debt-to-income ratio” floating around when applying for loans before, but what exactly does it mean? Simply put, your debt-to-income ratio compares how much debt you have in relation to your income. It’s a percentage calculated by dividing your total monthly debt payments by your gross monthly income.
This ratio gives lenders a quick snapshot of your ability to manage debt and make loan payments. Generally, the lower your debt-to-income ratio, the better positioned you are to qualify for a new loan and get approved at a decent interest rate.
Lenders have different thresholds, but a debt-to-income ratio above 43% often raises red flags. Once you cross over 50%, it becomes very difficult to get approved for financing. I know – math was never my strong suit either! But understanding your debt-to-income ratio is crucial if you need to get a loan approved despite high debt levels compared to income.
The good news is there are strategies you can use to improve that ratio, find alternative lending options, and still get the funding you need. Let’s break it down step-by-step so you can beat the odds and get the green light on a loan even with less than ideal finances.
Lowering Your Ratio By Paying Down Debts
Obviously, reducing the amount of debt you have is the fastest way to improve your debt-to-income ratio. Here are some smart moves to pay down balances:
- Pay more than the minimum payment on credit cards and loans. This will accelerate how quickly you pay off debts. Even paying $20 extra on a credit card balance can make a surprising dent over time.
- Prioritize paying down high-interest debts first. Credit cards, payday loans, and other debts with double-digit interest rates hurt the most. By focusing extra payments on those balances, you’ll pay less interest over time.
- Consolidate multiple debts into one for simplified payment. We’ll talk more about debt consolidation options later, but combining debts into one can make it easier to pay down balances faster.
- Use windfalls wisely. Tax refunds, work bonuses, and monetary gifts can be great opportunities to knock out debts. Resist the urge to splurge and put that extra cash toward debt payments.
- Make lifestyle cuts to free up money. Take a hard look at expenses and trim where you can – pack lunches instead of eating out, downgrade phone plans and cable packages, cancel unused subscriptions. Small spending changes add up.
Paying down what you already owe will reduce the amount going toward debts each month and steadily improve your ratio. Just staying focused and diligent with payments makes a difference.
Giving Your Income a Boost
Increasing what comes in every month is just as important as reducing what goes out when you have a high debt-to-income ratio. Here are some ways to give your income a helpful bump:
- Ask for a pay raise or promotion at your job. Never hurts to request more compensation from your employer if you’ve been doing great work. Worst case, they say no.
- Find a side hustle or part-time job. The gig economy opens doors to make extra cash with ride sharing, food delivery, virtual assisting, freelance projects, and more.
- Turn a hobby into income. Monetize what you love doing – photography, baking, crafting, consulting in your professional niche – by selling online or locally.
- Rent out a room or property. Extra square footage can mean extra rental income. Rent out a spare bedroom, basement apartment, or other property through a site like Airbnb.
- Sell unwanted items. Old toys, clothes, electronics and more can net you quick cash selling locally or online. De-clutter and make money simultaneously!
- Ask to defer a loan payment. If approved, you can temporarily pause payments and redirect that money to pay other debts.
Any extra income you can generate helps offset debts and will improve your ratio. Get creative with ways to fatten up your monthly earnings.
Cutting Back On Expenses Wisely
Trimming your spending is equally important for freeing up more cash to improve debt-to-income ratio. but cutting back too aggressively can leave you feeling deprived. Here are some painless ways to reduce expenses:
- Identify needs vs. wants. Focus spending only on true necessities like housing, utilities, groceries and transportation. Limit splurges.
- Downsize housing. Consider getting a roommate or moving to a smaller, cheaper apartment or rental home.
- Eat at home more. Cooking at home saves a ton over dining out. Meal planning helps reduce food waste too.
- Renegotiate bills and rates. Call service providers to request lower rates on cell phone plans, cable packages, insurance policies, gym memberships and more.
- Use coupons, shop sales, buy store brands. Being a savvy grocery shopper saves so much money every month.
- Limit subscriptions. Audit monthly services and ditch ones you can live without – streaming sites, boxes, memberships, etc.
- Travel for less. Be flexible on dates and destinations. Use miles, points and discounts to cut travel costs.
- Pause retirement contributions. Temporarily stopping 401(k) contributions could free up monthly cash but should be a last resort.
With a little dedication, you can trim expenses substantially while still enjoying life. Every dollar you save is one you can allocate toward quickly paying down debt.
Correcting Credit Report Errors
Believe it or not, incorrect information on your credit report could be needlessly worsening your score and debt-to-income ratio. Here are some tips for fixing credit report errors:
- Request your free annual credit reports. Review all three major bureau reports to spot any inaccurate accounts, balances, late payments, etc.
- Dispute errors by mail. Follow each credit bureau’s dispute process. Include copies of supporting documents.
- Get added as an authorized user. Piggyback off of someone else’s good credit history. Make sure they have excellent credit first.
- Negotiate deletions. Work directly with creditors to potentially remove negative marks from your history in exchange for paying remaining balances.
- Add a consumer statement. If you can’t get an error removed, you can request to add a brief statement to your report explaining the issue.
Don’t let credit report mistakes cause you to overpay on loans or get denied because of a ratio inflated by wrong data. Check carefully and dispute what doesn’t line up with your records.
Refinancing and Consolidating Debts
Refinancing existing debts with better terms can be a smart move as well. You have a few good options:
- Consolidate credit cards with a 0% balance transfer. Transfer high-rate balances to a card offering 12-18 months no interest. This temporarily stops accrual of interest so more payments go to principal balances.
- Take out a personal loan. Unsecured loans typically have lower fixed rates than credit cards. Consolidate cards into this one fixed monthly personal loan payment.
- Tap home equity. A home equity loan or line of credit lets you use your home’s value to consolidate other debts at lower interest. But your home is at risk if you default!
- Refinance student loans. Student loan refinancing from a private lender could possibly lower your rate, shortening repayment. Federal loans lose protections though if refinanced.
- Extend auto loan terms. Stretching out the repayment period lowers the monthly payment, but results in more interest paid over the life of the loan.
Consolidating multiple payments into just one loan with better rates can potentially improve your ratio. Run the numbers to see if refinancing helps or harms your situation.
Exploring Debt Consolidation Options
Speaking of consolidation, combining multiple debts into one through a consolidation program or loan is a great way to simplify payments and quickly improve your debt-to-income ratio. Here are some smart consolidation moves to consider:
- Enroll in a nonprofit debt management plan. This lets you consolidate credit cards into one payment and negotiate lower interest rates with card companies – often around 8-10%. There’s usually a small monthly fee, but overall savings are significant.
- Get a debt consolidation loan. Banks, credit unions and online lenders offer debt consolidation loans allowing you to roll multiple debts into one personal loan with fixed monthly payments at a lower rate.
- Open a 0% balance transfer card. As mentioned earlier, transferring credit card balances to a card like this lets you pay 0% interest for over a year in many cases, saving substantially on finance charges.
- Tap available home equity. A home equity loan or line of credit uses your home’s equity to consolidate other debts into one payment at an often lower and tax-deductible rate. Your home is then collateral, however.
- Take out a 401(k) loan. Borrowing against your 401(k) balance isn’t recommended, but it is an option. 401(k) loans don’t require a credit check either. Just be sure to repay on time to avoid penalties!
Any of these debt consolidation strategies can simplify your finances, reduce interest paid, and accelerate paying down your principal balances. All good for improving that debt-to-income ratio!
Turning to Alternative Lending Sources
Here’s the reality – when you have a high debt-to-income ratio, traditional brick-and-mortar banks and lenders are less likely to approve you for financing. But there are several alternative online lending sources worth exploring:
- Online lenders for bad credit. Companies like Avant, LendingClub and LendingPoint cater to borrowers with credit challenges and high debt-to-income ratios. Rates are higher but approval is possible.
- Peer-to-peer lending. On sites like Prosper and Upstart, individuals fund personal loans sidestepping banks. Interest rates can be competitive with chances of approval for all ratios.
- Credit union lending. Even with higher debt levels, credit unions may be willing to work with members they have an existing relationship with. It never hurts to ask!
- 401(k) or life insurance policy loans. Borrowing against existing retirement accounts or life insurance policies is an option. These require no credit check for approval but aren’t ideal solutions long-term.
- Hard money loans. If you have equity in a home or other asset, specialized lenders may offer financing based more on collateral than your ratio. Rates are often very high however.
- Subprime mortgages. Mortgages for borrowers with credit challenges do exist but expect to pay higher rates and closing costs. An FHA loan is one example requiring just a 3.5% down payment.
Do your homework to find an alternative lender willing to look past ratio limitations and get you a loan. Their rates won’t be rock bottom, but it beats not being approved at all.
Other Strategies for Getting Loan Approval
If you’ve made strides to improve your debt-to-income ratio but still need a little nudge for loan approval, a few other things can help seal the deal:
- Provide collateral. Putting up an asset as collateral – car, jewelry, stocks, etc. – can motivate an on-the-fence lender to greenlight your loan. Just know the asset could be seized if you default on payments.
- Get a cosigner. Asking a friend or family member with good credit and finances to co-sign reduces the lender’s risk. Your cosigner is then also on the hook for repayment if you default, however.
- Explain special circumstances. If you have unusual circumstances like recent medical bills or job loss temporarily impacting your ratio, explain this to the lender. It could make them more sympathetic.
- Try a different lender. Each lender has their own thresholds. If possible, apply with multiple lenders to increase chances of approval. Cast a wide net and be persistent.
- Offer to make larger down payment. Putting more money down upfront shows good faith and can offset credit or ratio concerns. If you have the savings, offer a larger down payment.
Getting creative, asking around, and pitching yourself to lenders can help you overcome less than perfect finances or ratio to still get approved. Where there’s a will, there’s usually a way.
Handling High Ratio Loan Payments Wisely
If you do succeed in getting approved for a loan despite your high debt-to-income ratio, make sure you borrow wisely and handle the payments responsibly:
- Budget each month. Know exactly how much is coming in and how every dollar will be allocated before getting hit with new loan payments. Account for all bills and expenses accurately.
- Pay more than minimums when possible. Making loan payments above the minimum due will pay down principal faster, shortening the loan term and saving on interest.
- Split up windfalls. Use bonuses, tax refunds and monetary gifts to make extra principal payments on loans and further accelerate repayment.
- Refinance if ratio improves. As you pay down debts and increase income, refinancing could get you better loan terms over time. Check if refinancing later helps or hurts.
- Monitor your credit. Keeping tabs on your credit score and report ensures mistakes won’t derail financial progress. Dispute errors quickly.
- Ask about hardship options if needed. If you hit hard times, ask lenders about hardship assistance programs. Temporary solutions like deferment could help you get by.
With smart budgeting, dedication to payments in full and on time, and ongoing monitoring of credit, a loan can improve rather than worsen your situation. Remain cautious but don’t fear loans entirely if your ratio is not ideal.
As you can see, there are many avenues for getting a loan even if you have a high debt-to-income ratio working against you currently. With determination, savvy financial moves, and a little extra work, approval is very possible. Reducing debts, increasing income, tapping alternative lending sources, and consolidating payments are all key strategies to employ.
Stay focused on incrementally improving your ratio every single month through extra payments, side gigs, and cost cutting. And don’t get discouraged if one lender denies you. Persistence and creativity are key – keep knocking on doors and explore every option to get the financing you need. I have no doubt with diligence and patience, you’ll get to yes on a loan and be on your way to a brighter financial future. You’ve so got this!