When most people think about applying for a loan, whether it’s for a new car, a mortgage, or a credit card, the first thing that comes to mind is their credit score. While that three-digit number certainly plays a significant role in the approval process, it’s only part of the story.
Lenders dig deeper. They use several financial ratios to measure how you’re managing money and how likely you are to repay the loan. Think of these ratios as a snapshot of your financial health. The better your numbers look, the easier it is to qualify and receive favorable terms.
In this article, we’ll help you understand what lenders look for and provide steps you can take to improve your ratios – and boost your chances of being approved.
#1 – Debt-to-Income Ratio
Are You Overextended?
Your Debt-to-Income Ratio (DTI) is one of the first figures lenders will calculate and review. Its purpose is to allow lenders to view how much of a borrower’s current monthly income is spent on outstanding debt – and whether they can afford to take on more.
How It’s Calculated:
DTI = (Total Monthly Debt Payments ÷ Gross Monthly Income) x 100
For example, if you earn $5,000 a month and spend $1,500 on debt like a mortgage, car loan, and credit card, your DTI is 30%.
Why It Matters:
The lower your DTI, the less risky you appear to lenders. A ratio below 36% is considered ideal; however, some financial institutions may approve up to 40-45% if other ratios are favorable. A higher DTI means more of your paycheck is already spoken for, leaving less room for new loan payments.
How to Improve It:
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Focus on paying down existing debts, starting with high-interest credit cards.
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Avoid taking on new debt before applying for a loan.
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Consolidate high-interest debts into a lower-rate personal loan to lower your monthly payments.
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Increase your income by taking on extra hours at work, through a side hustle, or by freelancing your skills. Even a small bump in take-home pay will have a positive impact on your ratio.
#2 – Unsecured Debt Ratio
How Much Debt is Backed by Collateral?
Not all debt carries the same weight to lenders or on your credit score. Mortgages and auto loans are backed by collateral, which means the lender can recover losses if you cannot repay the debt. Unsecured debt, such as credit cards and personal loans, has no safety net for the lender – making it riskier.
How It’s Calculated:
Unsecured Debt Ratio = (Total Unsecured Debt ÷ Annual Income) x 100
For example, if you earn $45,000 per year and have $5,000 in unsecured debt, your DTI ratio is approximately 11%.
Why It Matters:
While each financial institution is different, most lenders prefer this figure to be below 25%. Higher levels of unsecured debt suggest you’re heavily reliant on borrowing without assets to balance the risk.
How to Improve It:
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Prioritize paying off credit cards since they typically have the highest interest rates.
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Use a debt consolidation loan from the credit union to replace multiple high-interest balances with a single, lower-rate payment.
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Hold off on using or applying for new credit cards until the balance is better under control.
#3 – Credit Utilization Ratio
Are You Maxing Out Your Credit Cards?
Your Credit Utilization Ratio (CUR) measures how much of your available revolving credit, such as credit cards or personal lines of credit, that you’re using or utilizing at any given time. It provides lenders with a quick snapshot of how you manage your money. This figure also plays a significant role in determining your credit score.
How It’s Calculated:
CUR = (Total Credit Balances ÷ Total Credit Limits) x 100
For example, if you owe $3,000 on credit cards that have a combined credit limit of $10,000, your CUR will be 30%.
Why It Matters:
Lenders want to see this number low – ideally under 30%. Borrowers who tend to have excellent credit scores often stay under 7%. High credit utilization suggests you may be overly reliant on credit cards to make ends meet.
How to Improve It:
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Pay down credit balances as much as possible before applying for a loan.
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Request a credit limit increase on your card but refrain from using it. A higher credit limit will instantly improve your CUR if you don’t add to your current credit card balance.
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Are you the type of person who makes most purchases with a credit card to rack up rewards – then pays the full balance before the due date? If so, your CUR might be higher depending on when you apply for a loan. Try to avoid this tactic in the month prior to applying.
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If your credit balances are too high, consolidate the debt into a lower-rate personal loan with the credit union. This tactic will reduce your interest charges and instantly lower your CUR.
#4 – Loan-to-Value Ratio
Are You Borrowing Too Much?
For collateral-backed loans, such as home or vehicle loans, lenders calculate the Loan-to-Value Ratio (LTV). This figure measures how much you’re borrowing compared to the appraised value of the asset.
How It’s Calculated:
LTV = (Loan Amount ÷ Asset’s Appraised Value) x 100
For example, if you’re buying a $200,000 home but only financing $180,000, your LTV will be 90%.
Why It Matters:
A higher LTV means the lender takes on more risk, because if you default, selling the home or car may not cover the full loan balance. For mortgages, staying below 80% helps you avoid private mortgage insurance (PMI). For auto loans, most lenders prefer the loan balance to be less than the car’s value.
How to Improve It:
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Make a larger down payment to shrink your LTV.
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Choose a more affordable house or car that requires less to be financed.
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Avoid costly add-ons at the dealership, such as “ding” protection and extended warranties. These items will cause your loan amount to instantly jump, but they do not affect the car’s value.
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When refinancing a secured loan, wait until the home appreciates in value so your ratio improves naturally. If you’re refinancing a vehicle, wait until you’ve made several payments to offset the impact of depreciation.
Putting It All Together: Strengthening Your Odds
While your credit score remains an important factor, there’s a reason lenders review these ratios – they tell a much bigger story. When you calculate these figures yourself and take steps to improve them, you’re not just boosting your loan approval odds – you’re building healthier long-term financial habits.
Here are a few steps you can put into action right away:
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Review your current DTI, unsecured debt ratio, CUR, and (if relevant) LTV.
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Pick one weak spot to tackle first, such as paying down a credit card balance or creating a budget to free up extra funds.
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Utilize tools from the credit union to simplify the process, such as debt consolidation loans that can instantly lower interest charges and your monthly payments.
We’re Here to Help!
Getting approved for a loan shouldn’t feel like a mystery. Once you understand what lenders are really looking for, you can prepare in advance and apply with confidence. The best part is that improving these ratios doesn’t just help with loan applications, but it also strengthens your overall financial situation.
If you have questions about loan approvals or want to explore debt consolidation options, we’re ready to help. Please stop by the Credit Union or call 410-687-5240 to speak with a member of our lending team today.