Your credit score might seem like the be-all and end-all when applying for student loan refinancing, a car loan or a mortgage. But even with a solid credit history and cash flow, you could be denied funding.
There’s one factor you might not be considering: debt-to-income ratio.
- What is a debt-to-income ratio?
- What about front-end vs. back-end DTI?
- How do student loans impact your debt-to-income ratio?
- How do debt-to-income ratio, student loans affect your mortgage?
- How can you improve your debt-to-income ratio, student loans and all?
Your debt-to-income ratio is a percentage of how much debt you owe relative to your income. Often referred to as a “DTI” ratio for short, it’s an important number in your financial life.
When applying for a loan or other type of credit, many lenders look not only at your overall credit score, but also at your DTI to determine if you’re a good candidate. If a large chunk of your income is going to debt each month, lenders may be wary of extending further credit.
The lower your debt-to-income ratio, the better. But if you have pesky student loans, they could be pushing your DTI into the red zone, which can make you look risky to creditors and make it difficult to reach your financial goals.
As if the whole concept of debt-to-income ratio weren’t complicated enough, you actually have two different DTI ratios: front-end DTI and back-end DTI.
Your front-end debt-to-income ratio is how much of your gross income goes toward housing costs, such as mortgage payments and insurance. If you don’t yet own a home and are applying for a mortgage, your front-end DTI is what you would be paying if you were approved.
Your back-end debt-to-income ratio is how much of your gross income goes toward all of your debt obligations, including credit card payments, student loan payments, mortgage — even child support and alimony.
Typically, lenders would like your front-end DTI to be 28% or less. For back-end DTI, the standard benchmark is typically 35% or less. These numbers aren’t set in stone and may vary by lender, but if you have a generally high debt-to-income ratio, you may have difficulty getting approved for new loans.
In fact, according to the Consumer Financial Protection Bureau (CFPB), 43% is the maximum DTI a borrower can have in order to get approved for a qualified mortgage.
Your student loans aren’t accounted for in the front-end DTI ratio, but that debt certainly impacts the back end. If you have a steep student loan balance, your DTI can be high — in some cases, too high, effectively limiting your options to buy a house while owing student loans, to refinance your student debt, and more.
For example, let’s say you are applying for a mortgage. Your gross income (before taxes) is $3,000 per month and your monthly debt breakdown looks like this:
- Estimated mortgage payment and insurance = $1,000
- Student loan payment = $300
- Credit card payment = $50
- Car payment = $200
In this scenario, your total debt payments add up to $1,550 per month. To find out your DTI, you’d divide your total debts by your gross income, or use the calculator below.
With either method, you’ll find that your monthly debt of $1,550, divided by an income of $3,000, comes out to a rather high DTI of 51.6%.
Debt-to-Income (DTI) Calculator
If over half of your income would be going to your debt obligations — as in the example above — you won’t get approved for that mortgage.
“I think debt-to-income ratios are about to become very problematic for people who carry student loan debt and want to buy a house,” said Aaron LaRue, a former product manager at Clara Lending, which is now part of SoFi.
“When applying for a home loan, debt-to-income ratios can be one of the largest limiting factors when calculating home affordability. I’d argue that this is a bigger issue than having a low credit score. As far as qualifying, it’s right up there with how much you have for a down payment,” LaRue added.
And if you don’t have much for a down payment, your DTI could matter even more. A down payment is a way for lenders to reduce risk — the more you pay upfront, the less they need from a mortgage. A 20% down payment is the standard amount if you want to avoid paying private mortgage insurance (PMI), although the Federal Housing Administration (FHA) loan program offers mortgages down payments as low as 3.5%.
But for younger generations, student loans may make home ownership a tough goal to achieve. Nearly 1 in 4 recent graduates say their education debt has stopped them from moving, let alone buying a home, according to our 2019 milestones survey.
If you’re thinking of applying for a credit card, mortgage, car loan, student loan refinancing or another type of funding, it’s important to not only maintain good credit, but a healthy DTI ratio as well.
For example, when mortgage lenders examine your back-end DTI, a large student loan payment can be “a killer,” according to LaRue. “A monthly payment of a few hundred dollars can translate to a loss of tens of thousands of dollars off of your maximum home purchase price,” he explained.
Before you go after a big financial goal, calculate your DTI ratio. If it’s too high, you may want to hold off for a while until you improve your situation. Otherwise, you’re much more likely to face rejection.
How your DTI impacts your student loan refinancing application
|I’ll let you in on a little secret: I was actually rejected for student loan refinancing, and honestly, I should’ve known better, considering I was making $30,000 at the time and my student loans balance was also at $30,000.|
Unfortunately, my situation then is still common these days. About 46% of student loan borrowers who left school in the last five years say that their outstanding balance trumps their salary, according to the 2019 survey cited above.
If your loans are the same level or even higher than your salary, it’s likely your DTI is also too high!
But before you give up on applying for a mortgage or refinancing forever, there are ways you can improve your debt-to-income ratio:
- Ask for a raise
- Earn more through side hustling
- Pay off your debt ASAP
In other words, to improve your DTI, you need to earn more, get rid of some debt, or both.
Given the example above, if you were to focus on eliminating your student loans and car loan, you’d be left with a prospective $1,000 mortgage payment and $50 credit card bill each month. And $1,050, divided by $3,000, comes out to a more reasonable 35%.
If you want to improve your debt-to-income ratio to pursue your big life goals, make it a point to pay off your debt as soon as possible and find ways to supplement your income. It could mean the difference between getting a letter that says, “Congratulations!” and one that begins, “We regret to inform you…”
By preparing now and understanding how student loans affect debt-to-income ratio, you can take the necessary steps to go after what you want without being automatically rejected.
Andrew Pentis and Dillon Thompson contributed to this report.
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1 Important Disclosures for Splash Financial.
Splash Financial Disclosures
Terms and Conditions apply. Splash reserves the right to modify or discontinue products and benefits at any time without notice. Rates and terms are also subject to change at any time without notice. Offers are subject to credit approval. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet applicable underwriting requirements. Not all borrowers receive the lowest rate. Lowest rates are reserved for the highest qualified borrowers. If approved, your actual rate will be within a range of rates and will depend on a variety of factors, including term of loan, a responsible financial history, income and other factors. Refinancing or consolidating private and federal student loans may not be the right decision for everyone. Federal loans carry special benefits not available for loans made through Splash Financial, for example, public service loan forgiveness and economic hardship programs, fee waivers and rebates on the principal, which may not be accessible to you after you refinance. The rates displayed may include a 0.25% autopay discount.
The information you provide to us is an inquiry to determine whether we or our lenders can make a loan offer that meets your needs. If we or any of our lending partners has an available loan offer for you, you will be invited to submit a loan application to the lender for its review. We do not guarantee that you will receive any loan offers or that your loan application will be approved. Offers are subject to credit approval and are available only to U.S. citizens or permanent residents who meet applicable underwriting requirements. Not all borrowers will receive the lowest rates, which are available to the most qualified borrowers. Participating lenders, rates and terms are subject to change at any time without notice.
To check the rates and terms you qualify for, Splash Financial conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, the lender will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
Splash Financial and our lending partners reserve the right to modify or discontinue products and benefits at any time without notice. To qualify, a borrower must be a U.S. citizen and meet our lending partner’s underwriting requirements. Lowest rates are reserved for the highest qualified borrowers. This information is current as of Feburary 1, 2021.
2 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 2.98% APR (with Auto Pay) to 5.49% APR (with Auto Pay). Variable rate loan rates range from 1.99% APR (with Auto Pay) to 5.34% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of October 26, 2020, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 10/26/2020. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at [email protected], or call 888-601-2801 for more information on our student loan refinance product.
© 2020 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
3 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
Subject to floor rate and may require the automatic payments be made from a checking or savings account with the lender. The rate reduction will be removed and the rate will be increased by 0.25% upon any cancellation or failed collection attempt of the automatic payment and will be suspended during any period of deferment or forbearance. As a result, during the forbearance or suspension period, and/or if the automatic payment is canceled, any increase will take the form of higher payments. The lowest advertised variable APR is only available for loan terms of 5 years and is reserved for applicants with FICO scores of at least 810.
As of 02/17/2021 student loan refinancing rates range from 1.91% APR – 5.25% Variable APR with AutoPay and 2.95% APR – 7.63% Fixed APR with AutoPay.
4 Important Disclosures for SoFi.
5 Important Disclosures for Laurel Road.
Laurel Road Disclosures
All credit products are subject to credit approval.
Laurel Road began originating student loans in 2013 and has since helped thousands of professionals with undergraduate and postgraduate degrees consolidate and refinance more than $4 billion in federal and private school loans. Laurel Road also offers a suite of online graduate school loan products and personal loans that help simplify lending through customized technology and personalized service. In April 2019, Laurel Road was acquired by KeyBank, one of the nation’s largest bank-based financial services companies. Laurel Road is a brand of KeyBank National Association offering online lending products in all 50 U.S. states, Washington, D.C., and Puerto Rico. All loans are provided by KeyBank National Association, a nationally chartered bank. Member FDIC. For more information, visit www.laurelroad.com.
As used throughout these Terms & Conditions, the term “Lender” refers to KeyBank National Association and its affiliates, agents, guaranty insurers, investors, assigns, and successors in interest.
Assumptions: Repayment examples above assume a loan amount of $10,000 with repayment beginning immediately following disbursement. Repayment examples do not include the 0.25% AutoPay Discount.
Annual Percentage Rate (“APR”): This term represents the actual cost of financing to the borrower over the life of the loan expressed as a yearly rate.
Interest Rate: A simple annual rate that is applied to an unpaid balance.
Variable Rates: The current index for variable rate loans is derived from the one-month London Interbank Offered Rate (“LIBOR”) and changes in the LIBOR index may cause your monthly payment to increase. Borrowers who take out a term of 5, 7, or 10 years will have a maximum interest rate of 9%, those who take out a 15 or 20-year variable loan will have a maximum interest rate of 10%.
KEYBANK NATIONAL ASSOCIATION RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE.
This information is current as of January 4, 2021. Information and rates are subject to change without notice.