Debt-to-Income Ratio: What Students Need to Know

Ben Luthi Published on August 15, 2019

debt-to-income ratio

Taking on student loans can impact your future in many ways, and one of those ways is through your debt-to-income ratio. This ratio is an important factor that lenders consider when determining whether to extend you credit.

Whether you’re planning to buy your own car or hoping to one day own your own home, the amount of debt you incur while you’re in school can affect your approval odds.

What is the debt-to-income ratio?

Your debt-to-income ratio, called DTI for short, is a quick snapshot that shows how much of your monthly income goes toward debt. If you’re wondering how to calculate a debt-to-income ratio, it’s relatively easy: simply add up all of your monthly debt payments and divide the total by your gross (pre-tax) monthly income.

For example, let’s say your annual salary is $45,000 — or $3,750 per month — and you have the following monthly payments:

  • Student loans: $500
  • Auto loan: $250
  • Credit card minimum payments: $200
  • Mortgage: $1,000

Combined, your payments total $1,950, and your monthly gross income is $3,750, giving you a DTI of 52%.

What is included in debt-to-income ratio?

In most cases, all of your debts are included in your DTI, including your student loans. The main exception is when you’re buying a home. In this scenario, the lender calculates two separate ratios: a front-end ratio and a back-end ratio.

With the front-end DTI, the lender is only concerned with your housing costs, including your mortgage payment, property taxes and homeowner’s insurance. In general, lenders like to see these expenses be less than or equal to 28% of your gross monthly income.

The back-end ratio, on the other hand, is the same ratio you’ll find with other loan types, and it includes all of your debts. While conventional mortgage lenders can go as high as 50% with the back-end DTI, they prefer 36% or lower.

While most of the focus when calculating your DTI is on debt, it’s important to remember that your income is a significant factor. This means that not only do your student loans impact your eligibility to get approved for credit in the future, but so does your field of study.

If you take on a lot of student loan debt to major in an area where your starting salary is relatively low, you can expect to graduate with a higher DTI than someone who graduates in a field with high first-year salary prospects.

What is a good debt-to-income ratio?

There’s no standard requirement for what your DTI should look like because every lender and loan type is different. That said, your DTI is a major indicator of credit risk and can give lenders an idea of how likely you are to be able to take on more debt. The higher your DTI, the riskier you are seen as a borrower.

Mortgage lenders typically have stricter DTI requirements because a mortgage is such a significant financial commitment. With other loan types, you’ll typically find it difficult to get approved if your DTI is 50% or higher, though there are some exceptions to that rule.

How your debt-to-income ratio impacts your future

Your DTI isn’t the only factor lenders consider, but it is a big one that goes hand in hand with your credit score.

With a low DTI, you represent a low credit risk to a new lender, and you’ll have a better chance of getting approved for a new loan or credit card with favorable terms. If you have a high DTI, however, you may get slapped with a higher interest rate or have your application denied altogether.

For example, let’s say you apply for a car loan after graduation and your DTI is relatively low at 25%. If you borrow $20,000 for 60 months and qualify for a 3.5% interest rate, your monthly payment will be $364, and you’ll pay $1,830 in interest over the life of the loan.

Now, let’s say your DTI is 45%, which causes your interest rate to increase to 5.5%. That changes your monthly payment to $382, which may not seem like a big difference. But over five years, you’ll pay $1,091 more in interest.

According to a study by the Hamilton Project, a physical health and education teacher is expected to put close to 26% of their first-year earnings toward student loan debt, while an industrial or manufacturing engineer is expected to use about 6% of their first-year wages. Other examples include:

  • Fine and studio arts: About 26%
  • Liberal arts: About 22%
  • Elementary education: About 17%
  • Political science and government: About 16%
  • Math and statistics: About 12%
  • Civil engineering: About 10%
  • Finance: About 9%
  • Mechanical engineering: About 7%

Remember, the amount of your income you use to pay off debt is the definition of your DTI. So if you’re starting out at around 25% with student loans alone, it’ll be difficult to take on any more debt without putting yourself in a difficult position.

How to lower your debt-to-income ratio

The best way to decrease your DTI is to pay off debt. But if you have federal student loans, it’s also possible to lower your DTI by getting on an income-driven repayment plan or by extending your repayment term with a graduated or extended repayment plan.

Depending on the plan you choose, it could significantly reduce your monthly payment, making your student debt easier to manage and lowering your DTI.

Before you do this, however, it’s important to keep in mind that extending your term with one of these repayment plans will result in more interest charges over the life of your loans. So while they may be a good solution if you’re struggling to make payments, it may not be as good of a solution if you’re simply looking to take on more debt.

The bottom line

Your debt-to-income ratio is an important part of your financial profile, and how you handle student loans in college can make a significant impact on your future credit opportunities.

To avoid racking up more debt than you need, consider ways to reduce how much you need to borrow, including:

  • Picking an inexpensive school
  • Getting a part-time job
  • Applying for scholarships and grants
  • Taking more credit hours to get through school faster

Also, it’s important to focus on getting student loans with low interest rates because a higher rate will result in a higher monthly payment.

If you’re an undergraduate student, federal student loans can typically offer the lowest interest rates. But if you’re a graduate student or an undergrad who has run out of federal loan options, private student loans may be a good alternative. If you do choose private student loans, make sure you compare your options using Purefy’s rate comparison tool, to get the best deal.

If you’re considering that path, use Purefy’s rate comparison tool to compare private student loan options and pick the one with the lowest rates based on your situation.