Debt-to-Income Ratio (DTI) and Student Loans

What is debt-to-income ratio? It’s a ratio that affects your ability to access a loan. The basic idea is if you have too much debt relative to your income, lenders might hesitate or refuse to give you the credit you need for a large purchase. Your debt-to-income ratio (DTI) most often comes up when buying a house, but it is also considered by potential landlords or lessors of cars. By pulling your credit report, someone can calculate your DTI and decide whether to loan, rent, or lease to you.

How do student loans factor in? Obviously, student loans are a form of debt. Like other loans, your student debt shows up on your credit report. A potential lender or landlord will see your loan and factor it into your DTI ratio. But student loans will affect your DTI differently depending on the situation. I am going to outline what specifically goes into a DTI ratio and how student loans factor into several scenarios.

How To Calculate A DTI Ratio?

Your debt-to-income ratio is calculated by comparing your monthly debt obligations with your monthly income. Let’s take a close look at both.

Your debt obligations consist of recurring debt, which is debt you cannot cancel at any time. This includes mortgage, rent, car loans, personal loans, monthly minimum credit card payments, alimony, child support, and, of course, student loans. These are debts that are not going to go away until you’ve fully repaid them.

What does not count? Despite the fact that you may have contracts with your internet, cable, or phone provider, you can technically pull the plug on these services any time, so they do not count. Nor do other kinds of utilities like electricity and water. Even your health insurance does not count in your DTI. Of course, the money you’re paying back to your cousin who lent you a few hundred bucks last month is not an official debt, so cross that off the list, too.

In the case of housing, if you are selling a home before purchasing a new one, or if you are leaving your current rental and moving into a new one, your monthly obligations to your previous home will not count. Rather, a lender or landlord will be looking at the monthly mortgage or rent payment of the new place and calculate how much of your income that will take up. They aren’t going to lend or rent to you if they think too much of your income will be eaten up by housing costs, even if you technically have the income to cover it. However, if you’re not moving or if you’re keeping your old home, your current mortgage or rental will be incorporated into your DTI.

Your income can include not just wages, salary, and tips, but also alimony and child support, Social Security benefits, and pension. Pretty much any money you take in on a monthly basis on the books can be considered income.

How do you calculate your DTI number? Add up all your debts and all your income. Simply take your debt number and divide it by your income number. Example: If you have $1,000 per month in debt obligations and $3,200 per month in income, divide 1,000 by 3,200 and your answer is .3125. Round that to .31, multiply by 100, and you have a 31% DTI ratio.

The Effect Of Student Loans On Debt To Income Ratio

Student loans can be tricky when calculating DTI. The reason is millions of borrowers have federal student loans, and federal loans offer a lot of different repayment options, like income-driven repayment plans or a graduated repayment plan. Private loans, because repayment options are far fewer, are pretty straightforward. I’m going to go through the most common situations where DTI is an important factor and discuss how student loans affect each situation.

Getting A Mortgage

Buying a home is probably the biggest purchase you will make in your life. Your experience obtaining a mortgage to finance said home depends on your own personal finances, including your DTI, as well as the rules of the lender you are dealing with. Many lenders sell the mortgages they issue (including our favorite online mortgage lenders) — your debt, that is — and the two biggest purchasers of mortgages are Federal National Mortgage Association (aka Fannie Mae) and the Federal Home Loan Mortgage Corporation (aka Freddie Mac). Fannie and Freddie issue guidelines to lenders to maintain quality of the loans they buy and insure. These include guidelines about DTI and student loans for getting a mortgage. The two companies work similarly, though they have different rules that guide each organization.

Both Fannie and Freddie have issued new guidelines regarding student loans and lending practices. These may affect your ability to get a mortgage, or they may even be the deciding factor. However, each lender is different and their adherence to guidelines may fluctuate.

New Fannie Mae Rules:

• The acceptable DTI ceiling is now 50%, up from 45%.
• Lenders may use the actual payment under an income-driven repayment plan to qualify borrowers if it appears on the credit report or if acceptable documentation of the student loan is provided.

Read the full Fannie Mae rules here.

New Freddie Mac Rules:

• Lenders may use the monthly amount reported on the credit report OR 0.5% of the original or current loan balance; the greater of the two must be used to qualify borrowers.

Read the full Freddie Mac rules here.

What shows up on your credit report is crucial. Sometimes if you are in an IDR plan, your actual payment (the lower IDR amount) may not show up, but your full payment (what you would be paying without IDR) does instead. Lenders may just take the full payment into account, or they will calculate a payment amount based on loan documentation or other guidelines.

If nothing shows up on your credit report, lenders are (per Fannie Mae rules) allowed to calculate your monthly obligation as 1% of your remaining loan balance, or a payment based on a 20–25 year amortization schedule. Or they might (per Freddie Mac rules) use 0.5% of your original or current balance.

Furthermore, many banks and lenders may have their own rules that are different (and more strict) than these standards. It can be hard to change bank policies.

It’s a good idea to pull your credit report a few months before you’re expecting to apply for a mortgage to make sure there are no surprises on the report that might compromise your ability to secure the mortgage. You are entitled to a free credit report every year from AnnualCreditReport.com.

It’s always good to communicate with your potential lender (or several potential lenders) regardless of your situation. Explain specifically what your monthly payment obligations on your student loans are. Be honest throughout the process. Their in-house lending rules may be flexible in some areas where you thought there would be a roadblock. It never hurts to ask!

We break down the most common experiences with this here: Getting a mortgage while on an income-driven repayment plan.

Getting A Car Loan

If you need a loan to buy a car and you have student loan debt, the lender will also be looking at your DTI. Usually, a DTI of 36% or below is ideal to get a reasonable deal on a car. If you’re making the regular, full payments on your student loans, your situation is pretty straightforward for the lender. However, once again, the IDR plans may not appear on your credit report, thus potentially throwing your DTI out of whack.

With no entities like Fannie or Freddie in the auto world, it may be harder to gauge what lenders are going to do because each has its own specific practices. Some lenders might understand IDRs completely, for example, and that might better your chances of securing a car loan. Some might still reject you. And some may be fuzzy on the details. If you can sit down and explain your loan situation — such as what kind of payment plan you’re in and how much you pay every month — you might have more success.

Renting A House Or Apartment

The effect of your DTI on your ability to rent a house or an apartment varies largely by location and property owner. We live in a huge country with wild differences in rent. Rents in New York City will be very different from rents in Nashville. Landlords also vary widely in their standards or rental management style. The landlords could be a couple who lives in the upstairs apartment and only has one rental, or the landlord could be a massive corporation, or something in between. Many landlords hire property managers to screen potential tenants and manage current rentals.

In general, landlords not only want to know that you have the money to pay, they want to make sure that the rent will not eat up too much of your income. They will be able to tell by calculating your DTI ratio and factoring in the rent of their property. Many landlords will require that the rent will amount to no more than 33% of your income. Some may be more lenient and go up to 45% or 50%. Again, this depends on the landlord or property manager.

Getting And Keeping Your Job

It’s routine for employers to run background checks on potential employees, but they might go deeper and take a look at your credit report and calculate your DTI. Why? Especially if your job entails money management or access to sensitive information, an employer may want to know that you can effectively manage your own finances.

There are so many factors out of your control that would raise your DTI, but may not compromise your ability to perform well at a particular job, even if it does require money management.

While we don’t recommend bringing up your DTI unless asked about it (you may be opening a can of worms that was never going to be opened anyway), it is good to have a narrative in place that doesn’t sound like a bunch of excuses, but frames you as a proactive manager of your situation, as opposed to a passive recipient. Especially if your student loans are a significant contributor to your DTI, you should prep a few answers about your education and how it may have helped you, how you are managing your debt, and your plans for repayment. 

And realize that your student loan debt could get you fired from your job.

Managing Your DTI Via Your Student Loans

Your student loans might be bringing your DTI too high to secure a mortgage, a car loan, a rental home, and more. You can’t negotiate your balance on your student loans, but if you have federal loans and you qualify for an income-driven repayment plan, it may give you a chance to significantly reduce your DTI. IDRs are not right for everyone, so you want to consider your financial situation carefully before you jump into one.

Checking on your credit report to make sure that everything is being accurately reported is a good idea too. While not common, sometimes the same loans are erroneously reported multiple times on a credit report, a mistake which will definitely affect your DTI.