When struggling to get approved for personal loans in Canada, your Debt to Income (DTI) can be a factor that affected your ability to get approved.
Your DTI compares your monthly debt payments to your monthly income to help lenders determine how likely you might be to afford your loan payments.
While a DTI score does not affect your credit score (like credit utilization ratio) it is something that many lenders look at, and a high DTI is like a warning sign for many.
Since your DTI is an indicator of your ability to pay back credit if you were to borrow and what kind of risk you might be, a lower DTI indicates a sufficient income and stability in comparison to the amount of credit used.
What is a Debt-to-Income (DTI) Ratio
Most Canadian banks and financial credit lenders use DTI as a signal in addition to a good credit score when evaluating a potential borrower. Your DTI is a balance between debt and income and calculated by subtracting monthly debt payment from your gross income.
Lenders prefer to see a lower ratio, and when you have too many debt payments it makes your application less interesting to them. Suppose that your debt payments were $2,000 per month, and your monthly gross income was $6,000 in total.
This means your DTI would be 0.33, or 33 percent, and calculated by dividing your debt payment by your income ($2,000÷$6,000) to determine the ratio. While the maximum DTI ratio will vary from lender to lender, most prefer to see a debt-to-income ratio lower than 36%.
If you have a DTI of 50% or higher you will probably find your personal loan options to be very limited.
How to Lower My DTI Ratio?
The first thing to do is not take on more debt. What you need to do is lower the amount you owe, and get rid of debt for a better DTI. Also avoid other debt mistakes so that you can lower your debt-to-income ratio sooner.
Start by making more payments towards your debt to lower it. If possible, pay off any loans you have ahead of schedule. It’s always wise to look into whether your outstanding loans carry a prepayment penalty, which you would find in your loan terms.
When paying off debt, some prefer to use the avalanche method, which is paying down the debt with the highest interest rates first. If credit card debt is a factor, in some situations a balance transfer can be an option, but a personal loan is often the better choice.
Looking for ways to reduce your debt and increase your income isn’t the easiest way of improving your DTI but it definitely is the quickest. Besides getting a better job you can also look at a side hustle or odd jobs to increase your income.
Speaking with your creditors about reducing your rate or extending the duration of your loan might also be options.
Improving your cash flow and non essential spending can also free up some of your finances to pay off what you owe earlier and help improve your debt-to-income ratio as well.
You might be interested to know that there is an indirect relationship between your credit utilization and debt-to-income ratio. While credit utilization would be a percentage of available credit for when you carry credit card balances and your overall debt capacity, when you pay off your credit cards this also reduces your monthly debt payments and will improve your DTI.
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