The answer is YES. But, how does a student loan affect your debt-to-income ratio? To find out the answer, you have to go through this article.
You want to buy a house, a car, or maybe refinance your student loan. Soon after applying for a loan you’re informed that your application got rejected. But, you have a good credit score.
So, what is the factor behind the rejection of your loan application? Think about it! Don’t know? Well, you might not be looking at your debt-to-income (DTI) ratio.
It doesn’t matter how long you are in the workforce. When you’re applying for a loan, apart from your credit score, your DTI ratio is an important number that determines your loan approval.
What is debt-to-income ratio?
The DTI ratio is calculated by dividing total recurring monthly debt by gross monthly income. Lenders use this to weigh your ability to repay old debts and handle additional debt. Basically, lenders check whether or not they can trust you with a new loan.
See more: Understanding debt-to-income ratio
How to calculate DTI ratio
Consider this: Suppose you have a monthly debt payment of $2,000; that is, $1,000 for a mortgage, $500 for a car loan and $500 for credit cards. Your gross monthly income is $6,000. DTI ratio will be your total recurring monthly debt divided by your gross monthly income. So, in this scenario, your DTI ratio will be ($2,000 / $6,000) = 0.33. So, your DTI ratio is 33%.
Do you have a pesky student loan? If so, then be careful. It can push your DTI ratio in the danger zone, and your creditors may see you as a risk. Hence, it’ll be difficult for you to achieve your financial goals.
You can calculate your DTI here: DTI calculator
Impact of student loans on debt-to-income ratio
A high DTI ratio affects your eligibility of taking out a loan. If your student loan balance is towering, your debt-to-income ratio can be high. So, in this case, if you want to take out a mortgage, your loan application might get rejected due to your high DTI ratio.
Consider the example below to understand this better:
Suppose your gross monthly income is $3,000 and you want to apply for a mortgage. Assume your monthly debt breakdown like this:
- Student loan - $550
- Credit card balance - $600
- Car loan - $300
In this context, your total debt sums up to $1,450 per month. So, your DTI is ($1,450/$3,000) = 48.33%.
Hence, almost half of your income is going toward your debt obligations, so it’s difficult for you to get approval for that mortgage.
It’ll greater your chance of getting a new line of credit.
In words of Aaron LaRue, founder of MortgageMonks.com, “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.”
Further, he added, “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.”
If your loans are same or higher than your salary, your DTI is likely to be too high. It is not good when you’re applying for a line of credit such as mortgage, car loan, credit cards, student loan refinancing, and so on. If this happens, your application might be rejected.
If you have a huge student loan and are planning to apply for a mortgage, then start your preparations from now and try to repay or lower your student loan balance as soon as possible.
Remember, a high student loan balance would result in rejection of your home loan.
How can you improve your debt-to-income ratio?
Besides credit score, your DTI ratio is another important number affecting your loan approval. When you’re applying for a mortgage, a steep student loan balance can be a killer. Before you aim a big financial target, you must calculate your DTI ratio. If it’s too high, then hold it back for a while until your situation improves.
Do you have a high DTI ratio? If your answer is yes, you can improve your DTI ratio by:
- Asking for a raise
- Earning more through a part-time job
- Paying off debt as soon as possible
- Recalculating the DTI ratio per month to check progress
- Postponing big purchases until you're able to save more
- Abstaining from additional loans
In simple words, you need to eliminate your debts and increase your income, or do both to improve your DTI ratio.
To conclude it can be said that,
It is good if you want to apply for a fresh line of credit. But, if you have a steep student loan balance, then you must try to repay or lower it. A high student loan balance means a high DTI ratio, which means your loan application might be rejected, as you’ll appear as a risk to your potential creditors.
Check out: 7 Unknown tricks that can help to improve credit score
