At a Glance
While a debt consolidation loan allows you to pay off your existing debt by combining it into a single loan, lenders typically like to see a healthy debt-to-income or DTI ratio before lending to you. For those with higher debt levels this can seem like a troubling hurdle, but by learning to calculate your own DTI and the loan options available to you, you can improve your debt today.
What is a high debt-to-income ratio?
The value considered to be a high debt-to-income ratio can fluctuate depending on the type of loan you seek, but generally a value above 43% is high. For some loans, such as consolidation loans, the max DTI lenders like to see may be as high as 50%, but it’s important to research every individual lender.
However, to answer the question of, “what is a high debt ratio?” properly you will need to calculate your own. By determining this value, you can also determine what debt consolidation strategies you may be eligible for.
How to calculate debt-to-income ratio?
The simple formula for calculating your debt-to-income ratio is to take all your existing debt and divide the value by your pre-tax income, then multiply by 100 to get your percentage. While this may seem easy at first look, determining all your forms of debt can pose a challenge. Here is an example that may help you to visualize the process. Say you have the following amounts in debt during a month:
- Student loan payments: $300
- Credit Card Minimum Payments: $200
- Auto loan payment: $400
This equates to a numerator of $900 in debt for the month. On top of this, say your pre-tax earnings are $3,000 for the month. When you divide these two values and multiply by 100, you get a debt-to-income ratio of 30%.
Options for debt consolidation with high DTI
Debt consolidation with high debt to income ratio can be a challenge, but there are various strategies and loan types to accomplish this goal. Specific high debt to income ratio loans, such as personal loans for high debt to income ratio, are designed to help those who may have a DTI above 40%.
1. Secured personal loan
While lenders may not be willing to provide you with an unsecured personal loan when you have a high DTI ratio, they may offer you a secured personal loan. The primary difference between these two types is that a secured loan requires a borrower to put down collateral. This collateral can be anything from your car to other assets you may own. The reason lenders are more willing to offer a secured personal loan to somebody with a high DTI is that in the event of non-payment by the borrower, the lender can still collect on something of value. Read more on the differences between secured and unsecured loans here.
2. Home equity loan
A home equity loan is a secured type of loan in which a borrower receives funds in exchange for offering equity in their home as collateral. As discussed earlier, this allows the lender to perceive the borrower as having less risk, so they are more willing to provide the loan. The amount of the loan is determined by the value of the property as determined by an appraiser. Read more on the best home equity loans here.
3. Loan with a co-signer
A co-signer offers a lender peace of mind with a riskier borrower as they are a backup plan in the event you default on the loan. If you are unable to meet the payments required by the loan, a co-signer assumes legal responsibility for that loan and all payments. This is a serious obligation so be sure to have a serious conversation with your potential co-signer. Read more about personal loans with cosigners here.
4. Debt consolidation program
A debt consolidation program is when a company communicates with lending agencies on your behalf in an effort to negotiate better terms. They assume the risk on your behalf, and your payments of the loan go to the company rather than the lender. Many government-approved debt consolidation programs are designed for those seeking how to get a loan with high debt-to-income ratio. Read more on this type of loan here.
Alternatives to debt consolidation loans
The primary alternatives to debt consolidation loans involve methods of reducing debt. Therefore, some of the best ways to learn how to consolidate your debt without getting a loan are:
- Seeking credit counseling: By learning how to improve your credit with the help of a professional, you can improve your debt-to-income ratio and potentially be approved for a loan in the future.
- Settle your debt: Debt settlement companies allow you to pay off a portion of your existing debt and, in return, they will pay off your debt in some cases.
- Declare bankruptcy: This should only be used as a last resort, as declaring bankruptcy can have longstanding implications on your finances. However, it can also allow you to reduce your debt in the event you cannot meet any of your payments.
How to lower debt-to-income ratio?
High debt to income ratio lenders would still like to see your DTI come down over time, so learning how to reduce this figure should remain important.
1. Pay off your loans ahead of your schedule
By paying off your loan balances in advance, in full, you can avoid accruing interest on your balances. In the long term, this will reduce the overall debt you have remaining to pay and will decrease the numerator for your DTI calculation.
2. Use a balancer transfer to lower the interest rates
High interest rates can quickly result in an increase of your overall debt, so reducing these interest rates should be a top priority. One of the most effective ways to do this is to utilize a balance transfer. Debt consolidation with high DTI will be made easier if you transfer your debt balances on various credit cards to a single card with a single interest rate. Learn more about this effective strategy here.
3. Restructure your debts
By speaking with the lenders for your various forms of debt, you may be able to restructure the terms of your loans or debts. Extending loan terms by a couple years may help reduce interest rates or principal payments. As just discussed, transferring your credit cards to a single card may result in a lower interest rate and less debt as a whole.
4. Increase income
To decrease your debt to income ratio for a debt consolidation loan, focusing on the denominator of the equation can be an excellent strategy if your debt is locked. Finding a second job or seeking higher pay at a different organization can be a quick way to reduce your debt-to-income level.
5. Refinance loans
Refinancing your existing loans may allow you to extend your loan payment terms, which will reduce your monthly payments and potentially change your interest rate. It’s worth noting that this strategy will keep you in debt longer, so it is not the desired option.
In most cases, yes, a debt consolidation loan will help your DTI ratio by reducing the amount of monthly payment you make on your debt and reducing the number of interest rates you pay.
A debt-to-income ratio of 36% and under is good, while anything above this value becomes increasingly more concerning for lenders. In general, you will be hard-pressed to find lenders willing to loan when your DTI is in the range of 46-50%.
A person’s income is not included in their credit score report, so your DTI ratio will never affect your credit score. However, debt by itself can affect your credit score if you are missing payments, so always be sure to meet your debt obligations in full.
A debt consolidation loan with high utilization can negatively impact your debt-to-income ratio. Credit utilization is simply the amount of available credit you are currently using that is not yet paid off. As a result of not being paid off yet, it factors into the numerator of your debt-to-income ratio.