Improving your debt-to-income ratio (DTI) before applying for a business loan or other type of financing reduces the risk of underwriting delays or being denied because of your finances. Consumer and business lenders have their own requirements for what makes a “good” DTI, but common ranges include:
- Low-risk DTI being under 36%
- Medium-risk DTI at levels between 36% and 45%
- High-risk DTI for numbers over 45%
DTI is a ratio that focuses on your personal finances, but small business lenders use it together with your business’s Debt Service Coverage Ratio (DSCR) to gauge whether you will still be able to make payments on a business loan if your company’s cash flow drops. Even if you have a high enough DSCR (most lenders want one above 1.25), a high DTI ratio can limit how much you can borrow, can increase the interest rates lenders offer, or may result in a denial, even when the business itself looks healthy.
A low DTI can help you get approved for a business loan if your DSCR isn’t as low as lenders want, because the low DTI shows lenders you’ll be able to cover business loan payments even if sales fall.
There are two ways to improve your debt to income ratio before you apply for financial products like a small business loan.
- Have a quiet period for personal finances
- Do a 30/60/90-day plan to improve your DTI
Quiet Period for Personal Finances
Having a quiet period of 90 to 120 days before you apply for commercial financing like business lines of credit or business loans is a good way to strengthen your ratio. This is a time frame where you avoid opening new credit accounts, applying for personal loans, or making large financed purchases before your business loan application so that underwriters don’t have to recalculate everything due to last-minute changes on your personal credit report. If 90 days is not doable, give yourself at least a 30-day window.
If your personal credit report changes during this time frame, it could cause the lender to make requests for more documents or even put your DTI over their internal minimums, which can result in higher interest rates, less than ideal terms, or a declined application.
Pro-tip: When possible, pay off or pay down personal debts and make sure your business lender knows about it when they calculate your DTI.
30/60/90-Day Plan to Improve Your Debt to Income Ratio
Your debt to income ratio measures how much you pay on personal debt each month (from mortgage, credit cards, and personal loans) compared to your total income. This means the biggest ways to improve your ratio come from tackling debts with relatively high monthly payments compared to their principal balance. Here are the steps to take in each of the three months leading up to your business loan application.
First 30 Days
The first 30 days is all about lowering your monthly debt obligations. Start by creating a spreadsheet listing all your personal monthly debt obligations, then focus on:
- Paying off small personal debts like buy-now-pay-later plans, short-term personal loans, and low-balance credit cards.
- Prioritizing debts where a payoff removes an entire monthly payment.
- Moving business expenses off personal credit cards, so they no longer count toward personal debt obligations.
If you make $10,000 income each month and have $5,000 monthly debt payments, your DTI would be 50%, which is high risk for most lenders.
Paying off a $1,000 “Pay in 4” charge from a recent vacation expense you split over 4 months lowers your DTI to 40% ($4K debt divided by $10K income) and puts you into the middle of the medium risk tier for business lenders, helping your chances of getting approved.
Getting a debt consolidation loan can work in these first 30 days as long as you lower the monthly payment. Combining 3 loans into 1 with a longer payback period will cost more in total interest over the life of the loan but will lower your monthly payment and improve your DTI.
Days 31–60
Your goal for days 31 to 60 is to review your records and make sure business lenders will accurately calculate your global cash flow from both personal income and business receipts.
Lenders start with your adjusted gross income (AGI) and then add back or subtract out non-cash or non-recurring items to determine your stable cash flow, but they can overlook or miss important items. By reviewing documents yourself, you’ll be prepared to catch any errors or omissions they might make.
Start by reviewing your tax returns and any investment decisions to identify big changes in items that are added back or subtracted from global cash flow when calculating DTI. Examples include:
- Changes in depreciation and amortization, like using a section 179 deduction to expense a large purchase that made your income look artificially low last year.
- One-time gains or losses like a loss on selling a piece of real estate you owned. That loss won’t happen again and you’ll have extra cash from not paying property tax, insurance, and other ownership costs.
- Tax changes like moving from a high tax state to one with no income tax.
- Selling a stock with no dividend for another stock that pays a high yield.
Document any items that show the lender you’ll have higher (or at least not lower) cash flow in future years so they can accurately determine your risk through global cash flow, even if your DTI isn’t strictly changed.
Days 61–90
Use the final 30 days of your 30/60/90-day plan to double check that you didn’t miss any items and fix anything that slipped through the cracks. Look for:
- Monthly business cell phone bills that didn’t get charged to business credit cards.
- Announcements from companies where you own stock, which had dividends.
- Raises you got at a job that are not related to the business taking the loan.
- Business expenses that are still getting charged to personal cards.
- Subscriptions you canceled but vendors are still billing you for.
Get a copy of your personal credit report, and double check that each account and tradeline listed from the credit bureaus is accurate. If not, contact the lender, bank, or credit card company directly and get them to notify the credit bureau of debts you’ve already paid. Ask the lender for a letter of payoff or current balance on their company letterhead if you can’t get this reflected on your credit report in time, and give your business lender a copy of the letter.
If you have a strong relationship with your lender, ask them for a call during these final 30 days and walk them through your own debt schedule and DTI calculation to see if they agree. This builds their confidence in your financial discipline and expertise.
Your debt-to-income ratio shows the percent of total gross monthly income that you pay toward personal debt. Small business lenders use your DTI together with your business’s debt service coverage ratio to see your global cash flow, and these help them determine your risk as a borrower.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
