Does Debt-to-Income Ratio Include Student Loans?
Understand how student loans factor into your Debt-to-Income ratio and its impact on your borrowing power.
A debt-to-income (DTI) ratio indicates how much of an individual’s gross monthly income is allocated to debt payments. Lenders use this metric to evaluate a borrower’s capacity to manage additional financial obligations, particularly when seeking new credit. Understanding the components of this ratio provides clarity on one’s financial standing.
Debt-to-Income Ratio Explained
The debt-to-income ratio is a percentage that compares your total recurring monthly debt payments to your gross monthly income. This calculation provides lenders with a clear picture of your financial obligations relative to your earnings, helping them assess your ability to take on new debt. It also signals whether your current debt load is manageable.
The ratio is composed of two elements: your total monthly debt payments and your gross monthly income. Gross monthly income refers to the money you earn before taxes, deductions, or other expenses are subtracted. This can include your salary, wages, bonuses, commissions, or consistent rental income.
Total monthly debt payments include minimum payments for credit cards, auto loans, personal loans, and existing mortgage or rent payments. Utility bills, groceries, and insurance premiums are generally not included. Lenders use this ratio for various loan applications, such as mortgages, car loans, and personal loans.
How Student Loans Affect DTI Calculation
Student loans are factored into debt-to-income ratio calculations, impacting the “debt” portion of the equation. The method of calculation for student loan payments varies depending on the loan’s current status and the specific lender’s guidelines.
For student loans in active repayment, lenders use the actual monthly payment amount reported to credit bureaus. This reflects the current financial obligation the borrower faces each month.
When student loans are in deferment or forbearance (no payments currently required), lenders often use a hypothetical payment amount for DTI purposes. For instance, Fannie Mae may use 1% of the outstanding loan balance as the monthly payment if a $0 payment is reported. Freddie Mac might use 0.5% of the outstanding loan balance in similar scenarios. These percentages vary among different loan types and lenders, generally ranging between 0.5% and 1% of the loan’s total balance per month.
For borrowers on Income-Driven Repayment (IDR) plans, the actual monthly payment stipulated by the plan is typically used in DTI calculations, even if that payment is $0. For example, the Federal Housing Administration (FHA) uses the actual IDR payment amount as long as it is greater than $0; otherwise, they may use 0.5% of the loan balance. Both federal and private student loans are generally treated similarly in DTI calculations, with the focus remaining on the established or hypothetical monthly payment obligation.
Calculating Your Debt-to-Income Ratio
Calculating your debt-to-income ratio involves a simple, three-step process. This assessment helps in understanding your financial standing before approaching lenders.
First, determine your gross monthly income, which is your total earnings before any taxes or deductions. If you receive income from multiple sources, such as a salary, bonuses, or self-employment, add all these amounts together.
Next, sum up all your recurring monthly debt payments. This includes minimum payments on credit cards, car loans, personal loans, and any existing mortgage or rent obligations. For student loans, use the monthly payment amount determined by their current status, whether it is an active payment, a hypothetical payment for deferred loans, or an Income-Driven Repayment plan amount, as outlined previously. Do not include expenses like utilities, phone bills, or insurance premiums, as these are generally not considered debt payments for DTI purposes.
Finally, apply the debt-to-income ratio formula: divide your total monthly debt payments by your gross monthly income, then multiply the result by 100 to express it as a percentage. For example, if your total monthly debt payments are $1,500 and your gross monthly income is $4,500, your DTI would be ($1,500 / $4,500) x 100 = 33.3%. This percentage represents the portion of your income dedicated to servicing debt each month.
DTI and Lending Decisions
The debt-to-income ratio is a significant factor lenders consider when evaluating loan applications. A lower DTI ratio indicates a reduced risk for lenders, suggesting a borrower has sufficient income remaining after covering existing debts to manage new financial obligations. This can lead to more favorable loan terms and interest rates.
Lenders often have specific DTI thresholds they prefer for approval. A DTI of 36% or less is frequently considered ideal and indicates a strong capacity for managing additional debt. Some lenders, particularly for mortgage programs, may approve loans with DTI ratios up to 43%, though this can depend on other compensating factors like a strong credit score or substantial savings. For certain government-backed loans, such as FHA loans, DTI ratios can potentially be higher, sometimes reaching up to 50%.
A higher DTI ratio, especially exceeding 43%, can present challenges in securing new loans or may result in less attractive interest rates. While DTI is a determinant, it is one of several criteria lenders assess. Credit score, down payment amount, and financial reserves also play roles in evaluating a borrower’s creditworthiness.