How Student Loans Impact Your Debt-to-Income Ratio

Student loans can significantly affect your debt-to-income (DTI) ratio, which is an important factor lenders consider when you apply for financing like mortgages or auto loans In this comprehensive guide, we’ll explain what the debt-to-income ratio is, how student loans are calculated into the ratio, and most importantly – how you can improve your DTI even with student loan debt.

What is the Debt-to-Income Ratio?

The debt-to-income ratio compares the amount you owe each month to how much income you earn. It’s calculated by dividing your monthly debt payments by your gross monthly income

For example, if you have $2,000 in total monthly debt payments and you earn $5,000 per month, your DTI would be:

$2,000 / $5,000 = 0.4

0.4 x 100 = 40%

Lenders prefer to see a DTI of 36% or less when considering applicants for mortgages and other loans. A high DTI over 50% can make it very difficult to qualify.

How Student Loans Affect Your DTI

Student loan payments are included in your total monthly debts that make up the debt part of the debt-to-income ratio equation. Even loans in deferment or forbearance may still count.

This means the more you owe each month toward student loans, the higher your DTI will be, making it harder to qualify for financing.

For example, let’s say your total monthly debt payments are $2,000. Of that, $500 goes toward student loan payments. If those loans were paid off, your DTI would drop from 40% down to 30% ($1,500/$5,000), improving your chances of approval for a mortgage.

Student Loans in Deferment and Your DTI

If your federal student loans are in deferment or forbearance, you may be wondering how they count toward your debt-to-income ratio. After all, you aren’t required to make payments at the moment.

It depends on a few factors:

• Conventional loans: Lenders may use 1% of your total student loan balance or your previous monthly payment before deferment.
• FHA loans: They can be excluded from DTI if payments are deferred for 12 months or less.
• **VA loans:**They may be excluded if you qualify for student loan forgiveness at the end of deferment.
• USDA loans: They may be excluded if payments are deferred for 12 months or less.

The takeaway is lenders have some leeway on how they handle deferred student loans in the DTI calculation, but you absolutely need to disclose them on your application. Don’t assume they won’t count against you.

Strategies to Improve Your DTI Ratio

If your DTI is too high because of student loans, here are some potential solutions:

• Refinance student loans to lower your monthly payment and interest rate. This can immediately reduce your DTI. Just beware of losing federal protections.

• Change repayment plans for federal loans to get a lower monthly payment. An extended plan stretches out payments for up to 25 years.

• Enroll in an income-driven repayment (IDR) plan to base monthly payments on income, family size, and other factors. Some plans offer a $0 payment if income is low enough.

• Pay down balances on loans with the highest interest rates first to owe less each month in interest.

• Pay off smaller loans to remove them from your DTI ratio calculation entirely.

• Make extra payments when possible to pay loans down faster and reduce how much interest accrues.

• Consolidate loans to combine multiple federal loans into one new loan with an average interest rate. This can streamline monthly bills.

The bottom line is you have options to reduce the burden of student loans so they negatively impact your DTI less. Explore the pros and cons of each strategy above to find the right approach for your situation.

Sample DTI Calculation With Student Loans

Let’s look at an example DTI calculation for a borrower with student loans so you can see the math involved:

Gross monthly income: $5,000

Monthly debts:

• Rent: $1,200
• Car payment: $450
• Credit card payment: $150
• Student loan payment: $350

Total monthly debts:

• Rent: $1,200
• Car: $450
• Credit card: $150
• Student loans: $350
• Total: $2,150

DTI calculation:

$2,150 total monthly debts / $5,000 gross monthly income = 0.43

0.43 x 100 = 43% DTI

In this scenario, the borrower’s DTI is 43% and student loans account for $350 of the monthly debts. By finding ways to lower the monthly student loan payment, the borrower could potentially get their DTI below 40%.

What is Considered a Good DTI Ratio?

Here is a quick rundown of DTI recommendations:

• Less than 36%: Excellent
• 36% to 43%: Good
• 44% to 49%: Fair
• 50% or higher: Poor

Aim for a DTI of 36% or less for the best chances of loan approval and the most favorable rates and terms. But scores up to 43% may still allow you to qualify.

Go above 50% and most lenders will be hesitant to approve you for additional financing until you reduce the ratio.

Tips for a Better Debt-to-Income Ratio

Besides managing student loans, here are some other quick tips to lower your DTI:

• Pay down credit card balances
• Pay off car loans early
• Make extra mortgage payments
• Ask for lower APRs from lenders
• Negotiate lower monthly bills
• Have a roommate to split housing costs
• Boost your income with a side hustle

A lower DTI ratio will benefit you when it’s time to apply for a mortgage, car loan, or other credit product. It shows lenders you manage debt responsibly.

Common Questions about DTI and Student Loans

How are deferred student loans counted in DTI?

Deferred loans may still count toward your DTI, depending on the lender. Disclose these loans even if payments are paused so the lender is aware of your total debt obligations.

What’s a good DTI ratio for buying a house?

Ideally 36% or less for the strongest mortgage approval chances and the lowest interest rates. But scores up to 43% are still generally acceptable to lenders.

Can you buy a house with a high DTI?

It’s possible but challenging. You’ll have fewer lender options and may only qualify for FHA loans, not conventional mortgages. Expect higher interest rates too. The lower the better for DTI.

Does DTI matter for student loans?

Yes, lenders may review your DTI when you apply for private student loans. A high ratio above 50% can make approval difficult. Federal loans don’t require a credit check or DTI review.

How can I quickly lower my DTI?

Paying down credit card balances can provide one of the fastest DTI improvements. Increase income with a side gig if possible. Or move some debt payments to a 0% balance transfer card.

The Bottom Line

Your debt-to-income ratio takes student loans and all monthly debts into account compared to your income. A high DTI above 50% can negatively impact your chances of qualifying for mortgages, auto loans, and other credit products.

If student debt is dragging your ratio down, consider solutions like changing repayment plans, refinancing, or making extra payments. With some strategic adjustments, you can get your DTI within a more acceptable range and on track toward your financial goals.