Debt-To-Income Ratio For Student Loans
A debt-to-income ratio is one of the primary factors that is considered before a lender moves forward with a loan application. Other factors include your credit score, monthly income, savings, and repayment history. A higher ratio means financial imbalance and a lower ratio means you have the required budget to repay.
Learn how lenders calculate your eligibility and if there are ways to better manage it.
What Is The Debt-to-Income Ratio?
Within the consumer lending industry, a debt-to-income ratio is the total amount of your income that goes towards paying off your ongoing debts.
Precisely speaking, the debt-to-income ratio formula covers more than standard debts. It also takes into account all insurance premiums, fees, taxes, and principal paid.
Nonetheless, this term is commonly used as it serves as a well-known and convenient shorthand.
How To Calculate It?
The calculation seems rather straightforward, but the complexity increases as there are two variations of DTI.
Usually, you calculate your debt-to-income ratio by dividing the monthly payments with your gross income. Based on the numbers, if your DTI is higher than 40%, it is high-time to start cutting expenses.
| For instance, if Thomas makes a gross income of $2,000 per month and his monthly expenses are $950 (including loans and card payments), his DTI ratio is $950 divided by $2000 which equals 47.50%. |
Front-End DTI vs Back-End DTI
Front-end DTI contains only housing-related expenditures. It is calculated based on the future monthly mortgage payment, plus property taxes and homeowner’s insurance.
This is why a front-end DTI is also commonly known as the mortgage-to-income ratio.
| For instance, if you have a mortgage payment of $1,000 from your $4,000 gross income, your front-end DTI is 25%. The standard limit used by lenders for calculation is 28%. |
On the other hand, the back-end DTI is straightforward debt-to-income. This is a broader calculation that accounts for all the payables like personal loans, car loans, home loans, child support, or other borrowing. The standard accepted limits on DTI for standard loans is 36% and 41% for FHA loans.
Effect Of Student Loans On DTIR
Almost every lender that you authorize to do a credit check can pull out the required report and calculate your debt-to-income ratio to decide if approving your loan, lease, or rent application.
Similar to other debts, a student loan is also a type of debt and shows up on your credit history.
If you already have a lot of monthly expenses, they will show up on the credit report. Depending on the DTIR, the lender will either approve or deny your application.
Usually, lenders accept a DTIR of up to 43%. However, that also means you’ll have to make peace with relatively higher rates and stringent terms.
A higher DTIR makes it extremely difficult to get approval for newer loans.
Some other implications of a DTIR on student loans are:
- Ongoing student loans increase the DTIR on your credit report. This may impact your chances of getting a mortgage loan, especially Fannie Mae and Freddie Mac loans.
- If you need a loan to purchase a car and you have a student loan debt, the lender may also look at the DTI. Typically, a DTI of 36% or less is suitable for a moderate to low-interest auto loan. When you make regular, full payments on your student loans, the case is fairly clear for the lender. Then again, IDR proposals might not appear on your credit report, thus potentially increasing your DTI.
- Your DTI also impacts your chances of renting a place. Landlords want to make sure that you’ll be able to make timely payments. They can calculate your DTIR and factor the approximate rent. A higher DTIR means lower chances of getting approved. Even if you get the place, you might have to put in extra security deposits or settle for a higher monthly cost.
How To Improve Your DTIR?
Improving your DTIR is easy, if you make it a habit.
There are two ways to lower your debt-to-income ratio
(a) by increasing your gross monthly income
(b) by reducing your total outstanding debts.
Here are some tried and tested ways to improve your DTIR:
- Avoid applying for new loans or cards temporarily
- Stop making unnecessary credit purchases
- Make extra payments on outstanding debts
- Stick to an add-on repayment/saving plan like debt avalanche, debt snowball, or debt snowflake
- Cut down on your daily expenses like dining out and coffee
- Take up some extra work or side gigs
- Check with your employer for a raise or promotion
- Borrow from friends or family to quickly clear off a few debts
Bottom Line
As you can see, lowering your DTIR is fully dependent on you. Take necessary steps to curb expenses and use the savings to quickly clear debts and improve your chances of receiving quicker approval and accessing better rates.
