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Student Loans and Your Debt-To-Income Ratio

Debt-to-income ratios have a huge impact on any credit decision. Student loan borrowers have opportunities to manipulate the numbers to improve future applications.

Written By: Michael P. Lux, Esq.

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Getting approval for a new mortgage, car loan, or student loan consolidation requires far more than just a credit score. Many student loan borrowers learn that despite their good credit score and a steady job, their debt-to-income ratio is an issue.

On many rejection letters, creditors will simply say the denial was due to insufficient income or because the debt relative to the income was too high. Today we will discuss how the debt-to-income ratio or DTI works, and how it can be improved in a short period of time.

Debt-to-income ratio basics and calculations

When a creditor checks your debt-to-income ratio they are looking at your monthly income and comparing it to the monthly bills that show up on your credit report.

Debt-to-income ratio includes the following:

  • Monthly mortgage payments
  • Minimum amount due on your credit card
  • Monthly car payments
  • Minimum due on each student loan
  • The minimum due on any other open lines of credit

Debt-to-income ratio does not include the following:

  • Cell phone bills
  • Utilities
  • Cable bills
  • Insurance costs

Creditors normally treat the debt-to-income ratio as a percentage. If your monthly debt accounts for half of your income each month, your debt to income ratio is 50%.

On most credit applications, potential lenders will not provide an actual debt-to-income ratio. Instead, they will simply say that your debt is too high relative to your income if the debt-to-income ratio is the basis for a denial.

Debt-to-income ratio issues

Student loans are a specific source of trouble for many borrowers looking for lender approval. If a loan is in forbearance or deferment, the credit report may not show what the expected monthly payment will be. Some lenders will deny an application on this fact alone. Others will use a certain percentage of the loan balance for use in the calculation.

Mortgage companies can also be really picky when it comes to federal loans and calculating your debt-to-income ratio. In many circumstances, they will just use the monthly payment, or 1% of the loan balance, whichever is greater, for making the calculation. If you are on an income-driven repayment plan and applying for a mortgage, this could be a very serious issue. We previously covered this problem in more detail.

Improving your debt-to-income ratio

Fixing this ratio can be an expensive task. It is complicated by the fact that some payments lower your debt-to-income ratio while others have no change. For example, a large payment towards your credit card debt will reduce your minimum monthly payment and improve your ratio. However, paying off a large portion of a car loan will not change your monthly bill and as a result, the debt-to-income ratio remains the same.

The best way to improve things is to target debts that you can eliminate entirely. If you have a student loan with a smaller balance that you can pay off in full, it will help your debt-to-income ratio. Paying off half of a very large loan will have no impact.

Another way to improve things would be to refinance your student loans. Lenders like SoFi and LendKey can potentially offer lower interest rates, and repayment plans up to 20 years (though the longer repayment plans typically come with higher interest rates). If you can lock in a lower interest rate and longer repayment plan, you can dramatically reduce your monthly payments on your student loans. This can free up extra cash each month for your higher interest debt and improve your debt-to-income ratio.

Creating a plan

Turning a rejection due to insufficient income requires some serious planning. You will need to figure out exactly which loans you are going to attack and get them paid off entirely. It is also important to pay attention to the reporting policy of the creditor. Paying off the loan isn’t enough. The zero balance needs to show up on your credit report. Once you have reduced your monthly debts according to your credit report, you will be in a much better position to get an approval.

Next steps

About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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