Before getting a personal loan from a bank or credit union, you’ll need to submit an application. Lenders will use a variety of factors to determine your creditworthiness. For example, a high credit score and positive payment history generally mean you’ll likely repay the loan as agreed. That’s less risky for them, so they’re more likely to approve your application and offer low interest rates.

Besides credit, they’ll also look at how much of your monthly income goes toward current debt. This is called your debt-to-income ratio.

DTI 101

Your debt-to-income ratio, or DTI, measures how much of your income goes toward your monthly debt obligations. This includes your credit cards, car loan payments, mortgage, student loans, and other installment loans.

If your DTI is low, the lender believes you have more cash available to handle your payments and are less likely to fall behind on the loan. By contrast, if your DTI is too high, the lender will think you have too much debt and are at a greater risk of defaulting on the loan.

DTI requirements vary by lender and loan product. For example, mortgage lenders typically require a DTI under 43%. The maximum debt-to-income ratio for a personal loan typically is 50%, but you'll have the best chance of qualifying for a loan with competitive rates if your debt-to-income ratio is lower than that.

Most personal loans are unsecured, so you don't have to provide any form of property as collateral. While that's advantageous for you as a borrower, the lack of collateral means the lender takes on more risk. As a result, lenders have strict eligibility requirements and will consider your DTI as part of their review process.

How to calculate your debt-to-income ratio

Although there are apps and online tools you can use to determine your DTI, calculating your DTI is simple; you can do it on your own by following these steps.

1. Add up your monthly debt payments: Review your billing and bank statements and add up all your required monthly payments. Include all forms of debt, including your credit cards, car payment, student loans, or mortgage.

2. Determine your monthly gross income: Lenders usually look at your pre-tax income — how much you make before taxes and other deductions are removed — to calculate your DTI. If you earn a regular salary, you can find this information by looking at your most recent paycheck. But, if you have a variable income or a side hustle, consider your average income: add up your earnings over three months and divide the total by three to get your average monthly income.

3. Divide your monthly debt payments by your gross monthly income: Divide the total amount of debt payments by your monthly income.

4. Multiple the result by 100: Multiply the result from step three to convert the number into a percentage.

For example, let's say you earn $4,000 per month and you have the following debt payments:

• $200 on a credit card

• $450 on student loans

• $450 on a car payment

In total, you pay $1,100 per month toward your debt. To calculate your DTI, divide that number by your gross income: $1,100 ➗ $4,000 = 0.275. Multiply that result by 100, and your DTI is 27.5%.

What is a bad debt-to-income ratio for a personal loan?

Although some lenders will issue loans to borrowers with DTIs as high as 50%, you have the best odds of qualifying for a loan — and securing a competitive rate — if your DTI is below 42%.

Although there are several factors impacting your eligibility for a loan, such as your credit history, lenders usually use the following scale when reviewing your application and DTI.

Qualifying for a personal loan with a higher DTI

If you have a higher DTI — such as 42% or higher — you may find that it's more difficult to qualify for a loan. However, you may be able to bolster your application and improve your odds of being approved with the following tips:

• Add a co-signer to your application: Although not all lenders allow it, you can increase the chances of getting a loan by adding a co-signer or joint applicant to your personal loan application. If the co-signer or co-applicant has good credit and a low DTI, they can help you qualify for a low-interest loan.

• Apply for a secured personal loan: If your DTI is too high, another way to qualify for a loan is to apply for a secured personal loan rather than an unsecured one. With a secured loan, you have to use some form of property as collateral, such as your car or bank account balance, to secure the loan. Having collateral reduces the risk to the lender since they can seize your property to recoup their money if you default on the loan.

How to improve your debt-to-income ratio

Your DTI plays a major role in your ability to qualify for a personal loan, auto loan, mortgage, and other new debt. If your DTI is too high and you have some time until you need to take out a loan, you can improve your DTI by following these tips:

• Pay down debt: The most effective way to decrease your DTI is to pay down some of your existing debt. If you pay off the lowest balance first, you can eliminate that monthly payment from your DTI calculation and lower your DTII. Creating a budget and cutting your expenses can help free up cash to pay down your balances.

• Increase income: Another way to better your DTI is to increase your income. If a raise is unlikely at your primary job, you can increase your income by picking up a part-time job or side gig and making some extra money in your spare time. As long as your income from that work is consistent, it can lower your DTI and help you qualify for a personal loan.

• Limit new credit applications: Every time you apply for new credit and the lender performs a hard credit check, your credit score may drop by a few points. And opening new accounts can cause your DTI to increase as you have to manage multiple monthly payments. Limiting new credit applications and only applying for a credit card or loan when you really need it minimizes the impact on your credit and prevents you from accruing unnecessary debt.