Throughout your life, you may want to take out many different kinds of loans, including student loans, a mortgage, and car loans. When you apply to borrow, lenders look at many factors, including your credit score and your debt-to-income ratio. But what exactly is your debt to income ratio, and how will student loans impact it? Here’s what you need to know about student loans and debt-to-income ratio calculations so you can be prepared for how your educational debt will impact future borrowing options.
What is your debt-to-income ratio?
When you apply to borrow, lenders want to ensure you are likely to repay your loan. As a result, they evaluate your financial credentials — including your debt-to-income ratio. Your debt-to-income ratio is a measure of your debt relative to your income. It’s also called DTI for short, and it’s calculated by dividing debt payments by your gross monthly income (your income before taxes are taken out).
Front-end ratio
While many lenders look at your debt-to-income ratio, this metric is critical when you are borrowing to buy a home. Lenders actually look at two different DTI ratios before approving you for a mortgage. The first is your front-end ratio. Your front-end ratio is a measure of how much of your income will go towards housing costs, including your mortgage principal, interest, taxes, and insurance. Lenders calculate your housing costs if you borrowed the desired amount and compare it to your gross income. If your front-end ratio is above 28%, you will have difficulty getting a mortgage from most lenders. When it comes to student loans and debt-to-income ratio calculations, your loans will not affect your front-end ratio. Only housing costs impact this calculation.
Back-end ratio
Your back-end ratio is a much broader measure of how much you owe relative to how much you earn. The back-end ratio considers all your debts, including student loans, credit cards, future housing payments, auto loans, personal loans, and more. Most lenders want your back-end ratio to be 36% or less, although the maximum DTI a borrower can have for a qualified mortgage is 43%. Your student loans affect this back-end ratio since all of your monthly debt payments are included in the calculation.
What are the rules for student loans and debt-to-income ratio
It’s important to understand the rules for student loans and debt-to-income ratio because if you have high payments on your student loan debt, you may have a hard time buying a house. When calculating your debt to income ratio, lenders look at your actual monthly student loan payment. For example, if you are currently paying $200 per month, this amount would be added to your other debts and compared to gross income to determine your DTI. The good news is that it is often possible to reduce your monthly student loan payment by selecting a different repayment plan, such as an income-contingent plan or a graduated repayment plan. By lowering your monthly payment, you could find it easier to qualify for a mortgage. You should be aware that if you cosign a student loan, it counts when your debt to income ratio is determined. This means that the educational debt you help others take on could affect your ability to borrow to buy a home.
Do deferred student loans affect debt-to-income ratio?
If your student loans are deferred, you do not have a monthly payment to make. As a result, you may be wondering, do deferred student loans affect debt to income ratio? Surprisingly, in most cases, the answer is yes. Lenders typically estimate a payment for your loans even if you currently pay nothing. The specifics for how this estimation works vary by loan program. While it may be disappointing to see this answer to the question, do deferred student loans affect debt to income ratio, it’s important to be realistic about what to expect when you want to borrow.
Student loan debt to income ratio calculator
In order to understand how your loans affect your borrowing abilities, it can be helpful to use a student loan debt to income ratio calculator. Most mortgage lenders make these types of calculators available online. For example, Student Loan Hero has a calculator where you can input your annual pre-tax income and your total monthly debt payments in order to calculate your DTI. You can also calculate your DTI manually. Just add up your payments, including student loans, and divide them by your monthly pre-tax income. So if you have $1700 in total payments, including future housing costs, student loans, credit cards, and other debt, and you make $5,000 per month, divide $1,700 by $5,000 to find out that your DTI is 34%.
How can you lower your DTI?
If you have a high debt-to-income ratio and this is affecting your ability to borrow, you have options including:
- Increasing your income by asking for a raise, looking for a side job, or looking for new employment
- Paying down debt
- Choosing a different student loan repayment plan
- Refinancing your student loans at a lower rate to reduce monthly payments
ELFI can help you explore options for affordable student loan refinance loans so your educational debt doesn’t make getting a home loan impossible.* Contact us today to learn more.
