Do Student Loans Affect Debt to Income Ratio? Yes

#1 Student loan lawyer

Updated on October 27, 2023

Buying a home while still paying off student loan debt is possible, but it largely depends on your debt-to-income (DTI) ratio – a key factor mortgage lenders use to determine your loan eligibility.

In this article, we’ll explain the significance of your DTI on your house-buying ability and provide tips to improve your chances of becoming a homeowner, even with student loans.

Related: Can I Buy a House with $100k Student Loans?

Do Student Loans Count Against Debt Ratio?

Yes, student loans count against your DTI ratio. But they aren’t your only factor. Personal loans, car loans, and credit card payments also play a part. When lenders assess your mortgage eligibility, they also consider your income and credit report.

Around 37% of first-time home buyers secure a home loan despite having student debt. To evaluate your risk as a borrower, lenders assess two DTI ratios: front-end and back-end.

The front-end ratio is the percentage of your gross income (your total monthly income before taxes and other deductions) that goes toward housing expenses. In contrast, the back-end ratio is the percentage of your gross monthly income used for all debt payments.

Most lenders focus on back-end DTI because it provides a complete picture of your personal finances and whether you can afford a new loan with your existing debt obligations.

You can use this formula to work out your back-end DTI:

  • DTI = (Total monthly debt payments + student loan payments) / gross monthly income x 100%

For example, let’s assume you earn a monthly income of $5,000 and pay off $200 in auto loan debt and $400 toward student loan debt each month.

  • Your DTI + ($200 + $400 / $500) = 0.12 (x 100) = 12%.

Mortgage lenders favor a back-end DTI ratio below 36%, with no more than 28% of your income going toward mortgage payments. A DTI ratio of 43% is usually the maximum accepted for FHA loans. Exceptions may reach 50%, but this is rare and considered high-risk.

Strategies to Improve Debt-to-Income Ratio with Student Loans

The two main ways to improve your DTI ratio include boosting your income or restructuring your budget to reduce expenses. Other strategies involve your lender and depend on whether you have a private or federal loan.

  • Income-driven repayment plans (IDR): If you have a federal student loan, you may qualify for an IDR plan, which restructures your monthly payment amount based on your income and family size.

  • Student loan refinancing: If you have a private loan and a good credit rating, you could ask your lender to refinance your loan with a modified interest rate and payment schedule. Lower monthly payment fees will automatically free up cash and decrease your DTI if your spending habits remain unchanged.

The Impact of Student Loans on Your Credit Score

Paying debt on time builds a positive credit score, but failure to make your monthly student loan payment damages it. Establishing a solid credit history is important because it affects your ability to take out loans and borrow credit at lower rates.

Your credit score can also affect whether you can rent an apartment, get a job, or qualify for a mobile contract. Landlords, employers, and consumer loan lenders usually check your credit report to determine your financial standing and reliability.

Related: Can I Get a Conventional Loan With Defaulted Student Loans?

Exceptions: When Student Loans Can Be Excluded from DTI

Student loans that have been forgiven, canceled, discharged, or paid are not included in DTI calculations. But credit bureaus can take 30 – 60 days to update your credit report and reflect a paid-off loan. So, as a precaution, contact your lender and credit bureau before applying for a mortgage preapproval to verify your current credit report is correct.

Related: If My Student Loans Are In Deferment, Can I Buy a House?

Maintaining Your Maximum Student Loan Payment for a Healthy DTI

The simplest way to maintain a healthy back-end DTI ratio is not to take on more debt while still paying off your student loan.

Succumbing to lifestyle creep (gradually buying more as your income increases) or collecting seemingly minor” purchases on your credit card can tip your DTI ratio toward unfavorable territory.

Keep your student loan payments a priority and try to pay more than the minimum amount whenever you can. Just double-check there are no prepayment penalties.

Student Loans and Mortgage Eligibility

Student loans don’t prohibit you from getting a mortgage. But the money you could put towards a down payment and regular mortgage payments go towards student loan debt instead, increasing your debt-to-income ratio.

Consider this scenario: You have a mortgage and a higher-than-average DTI ratio. Suddenly, you face an unforeseen yet substantial medical expense. Handling your current debt and covering the unexpected bill will become challenging and increase your mortgage default risk.

But a lower DTI signifies a higher disposable income and a greater ability to pay for unplanned expenses on top of your current debts, which makes you a lower risk for lenders. The less risk you are, the higher your chances of securing favorable mortgage terms.

The Broader Financial Implications of Student Loan Debt

In the 1960s, President Lyndon Johnson said, “Poverty must not be a bar to learning, and learning must offer an escape from Poverty.” Yet, today, the average student borrower only pays off their debt after 20 years, with some graduates taking over 45 years. Essentially, a lifetime.

Student loan debt decreases spending power, delays significant life milestones like buying a home or starting a family, and widens income inequality. It remains a systemic threat to the well-being of individuals and the country.

The Biden-Harris Administration recently announced an additional $9 billion in student debt relief for 125,000 Americans to alleviate heavy debt burdens and stimulate long-term economic growth.

Upcoming Student Loan Payments and the Housing Market

Federal student loan repayments have resumed for the first time since the COVID-19 pandemic, which global financial risk firm Moody’s has said could exacerbate the affordability crisis.

Borrowers struggling to afford student loans may be less likely to buy a home. This unaffordability may lower homeownership rates and hinder home price growth while increasing rental market demand.

Amid the current cost-of-living crises, individuals who are homeowners and must resume student loan payments may default on their mortgages and risk losing their homes due to foreclosures.

But those granted loan forgiveness could improve their financial standing, making qualifying for a mortgage and buying a home easier.

Bottom Line

Housing affordability is at the heart of the mortgage lending process. Securing a mortgage comes down to whether you can comfortably afford to pay it off, along with your student loan and other debts you may have.

While your DTI ratio may limit your borrowing options, with prudent planning and financial management, you can maintain a healthy balance between debt and income as you work towards homeownership.

If you are struggling to keep your DTI ratio low, The National Foundation for Debt Counseling (NFCC) can help improve your financial well-being.

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