A debt-to-income (DTI) ratio is the percentage of gross monthly income you use to repay debts, such as student loans, credit cards, and auto loans. In general, a debt-to-income ratio is a measure of your financial health. A low DTI ratio might indicate that you can afford to repay loans without experiencing financial hardship. Conversely, a higher debt-to-income ratio may appear that you are over-extended and do not have enough funds to repay your loans.
How Do Lenders Use the Debt-to-Income Ratio?
Lenders prefer borrowers who have a low DTI ratio. In general, college students might have a low ratio since most work part-time and have minimal debt. However, the FAFSA and many private lenders require borrowers to list their parent or guardian’s income, which may raise a DTI ratio. Ultimately, having a low DTI may increase your chances of receiving a student loan, especially from a private lender.
Keep in mind that the debt-to-income ratio is unrelated to your credit score. Your credit history does not appear in your income, so your DTI ratio does not appear in your credit reports. Instead, lenders calculate your DTI themselves using the information on your loan application and your credit history. Lenders then combine the debt-to-income ratio with credit scores, minimum income thresholds, and other factors to determine loan eligibility.
How to Calculate a Debt-to-Income Ratio
To calculate your debt-to-income ratio, follow these steps:
- Determine your total monthly loan payments.
- Divide the total monthly loan payments by your gross monthly income. (You can calculate gross monthly income by dividing your annual salary by 12.)
For example, say you owe $30,000 in student loan debt with a 5% interest rate and a 10-year repayment plan. Your monthly payment would be $318.20. If your annual income is $48,000, then your monthly salary is $4,000. Then, your debt to income ratio is $318.20/$4,000, which comes to 7.96%.
What Is a Good Debt-to-Income Ratio for Student Loans?
As mentioned above, a low debt-to-income ratio is always better because it means you can afford to repay more debt than someone with a higher DTI ratio. For student loans specifically, it is best to have a debt-to-income ratio under 10%. However, you may be able to stretch the ratio to a maximum of 15% if you do not have any other loans or debt payments.
Ways to Reduce Your Debt-to-Income Ratio
The most straightforward way to reduce your debt-to-income ratio is by lowering the amount of debt you have. This might mean cutting unnecessary expenses, such as streaming services, eating out, or gym memberships, to pay more than the monthly minimum amount. Additionally, consider paying with cash instead of credit cards. That way, you can ensure you do not overspend. Conversely, you may lower your DTI ratio by choosing a repayment plan with a more extended repayment period.
Speak to the Student Loan Debt Attorneys at McCarthy Law Today
If you are struggling with student loan repayment, reach out to McCarthy Law. Our student loan debt attorneys can help you manage your debt and guide you through repayment. Additionally, you may negotiate with private lenders to possibly lower the amount of debt and interest owed. The borrower typically pays a fraction of the remaining balance at the end of a successful negotiation, while the lender forgives the rest. To learn more about our services, schedule a free consultation by calling (855) 976-5777 or completing our contact form today.