When you refinance any type of loan, one of the things a bank or credit union takes into consideration is your debt-to-income ratio. While all lenders have their own standards, a debt-to-income ratio of 40% or more could be a sign of financial stress, according to the Federal Reserve. It could end your chances of getting approved.
If you want to refinance your student loan debt, it is a good idea to use a student loan refinance calculator, which takes into account your loan balance and the interest rate on the new loan, to determine how much you could save.
To make sure you get the best rate possible, you should also compare refinance lenders. Use your loan amount and your estimated credit score to determine which student loan refinance lender would save you the most in the long run.
What is a debt to income ratio?
A debt to income ratio is the percentage of your gross income that you use to pay off your debts. These payments can include rent, mortgage, credit cards, car loans, personal loans, student loans, alimony, child support, or any other unpaid debt you may have.
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To understand how to calculate the debt-to-income ratio, add up your monthly debt payments and divide the number by your gross monthly income. For example, if you pay $ 1,000 a month for rent, $ 125 on a credit card, $ 400 for your car bill, and $ 350 for your student loan. Let’s also say your monthly gross income is $ 3,500.
You would calculate your debt ratio like this:
- Debt: $ 1,000 + $ 125 + $ 400 + $ 350 = $ 1,875
- Income: $ 3,500
- Debt-to-income ratio: $ 1,875 / $ 3,500 = 0.054 or 54%
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A high debt-to-income ratio means that a large portion of your income is consumed by your debt, leaving you little room in your budget to cover expenses such as utilities, fuel, and groceries, which do not. are not included in the ratio.
How Does Your Debt-to-Income Ratio Affect Student Loan Refinancing?
A debt to income ratio will affect your ability to qualify for refinancing your student loan. They will also take into account your credit history, credit score, employment status, and savings.
You’re probably wondering what my debt-to-income ratio should be?
Typically, the maximum student loan refinancing debt-to-income ratio approved by lenders is 50%. If your ratio is too high, as in our example, you may not be eligible for refinancing your student loan. The lower your number, the better.
How Can You Improve Your Debt Ratio If Your Refinance Is Not Approved?
If you want to refinance your student loan debt, but your debt-to-income ratio is too high, there are steps you can take to improve your situation.
“Reduce your short-term running expenses, reduce your debt or expenses by making changes that may take longer to implement or increase your income,” suggested Chartered Financial Planner Sean M. Pearson of Ameriprise Financial Services in Conshohocken, Pennsylvania. Big improvements can be difficult, especially in the short term. The last two options take longer but may have more of an impact in the long run.
While calculating the debt-to-income ratio is straightforward, there are nuances in the debt payments you need to make in order to positively affect your ratio, said Ben Simiskey, a certified financial planner at Cornelius Stegent & Price LLP Certified. Public Accountants in Houston, Texas. .
“You should be focusing on paying off a debt in full,” he says.
For example, if you had $ 2,000 to spend on debt repayment, your ratio would improve more if you paid off a $ 2,000 credit card than if you paid $ 500 each on three credit cards and a car loan. , explains Simiskey.
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“You want to try to get rid of a payment altogether,” he said. “If you can’t pay a full balance immediately, I would focus on paying your minimum payments and spend any additional discretionary money on your lowest outstanding balance until it’s paid off. Then transfer the discretionary money plus the minimum amount you no longer have to pay on that balance to the next lower balance. Etc. “
Pearson said budgets are meant to be a way of life rather than something you turn on and off. Taking the time to reduce your debt ratio will not only help you qualify for your student loan refinance; it can help you if you want to buy a home or finance another major purchase.
“Often the small changes that accumulate over time have more of an impact than trying to make a big shot right away,” Pearson said.