Calculating Your Debt-to-Income Ratio while in College
If you are reading this post about your debt-to-income ratio (DTI) while in college, you are likely working on a homework assignment for financial and economics or you are considering a major purchase (home, vehicle) in the near future. While a college student’s debt-to-income ratio is calculated exactly the same as anyone else’s, students typically have a more difficult time achieving a ratio that lenders find acceptable.
If you are a college student and want to calculate your debt-to-income ratio, total up your current monthly debt payments (credit cards, store cards, gas cards, car/truck loan, etc.) and divide it by your monthly gross income (BEFORE taxes and deductions). Finally, multiply the resulting decimal by 100 to see your DTI expressed as a percentage.
Your debt-to-income ratio can never be a negative number, but in extremely difficult circumstances, it can be 100% or higher. What does it all mean and what is it used for? Great questions!
The Formula for Calculating your Debt-to-Income Ratio
Total up all your monthly debt payments, including credit cards, store cards, online retail cards, car or truck loan(s), and any other loans you are required to pay. You will generally not include your student loans unless you are currently required to make a monthly payment or unless you are less than 12 months from having to make your first payment (which usually occurs about 7 months after graduation).
Next, divide that monthly debt payment figure by your monthly gross income (BEFORE taxes).
The resulting number will usually be greater than 0 but less than 1. If your monthly debt payments are greater than your income, your resulting figure will be greater than 1 (and you should seek immediate help from a nonprofit credit counselor or, in worst-case scenarios, a bankruptcy attorney).
Finally, multiply the figure by 100 to show your DTI as a percentage.
College Student Debt-to-Income Ratio Example:
Visa Card Monthly Payment: $80
MasterCard Monthly Payment: $35
Store Card Monthly Payment: $25
Car Payment: $250
TOTAL MONTHLY PAYMENTS: $390
TOTAL MONTHLY GROSS INCOME: $900
$390 ÷ $900 = .43
.43 x 100 = 43% Debt-to-Income Ratio
You can also use our student debt-to-income ratio calculator for an estimate of how lenders may view your creditworthiness.
Do You Want a High or Low Debt-to-Income Ratio?
Your DTI is a quick method that lenders use to determine how much of your total income you are using to service (pay) your monthly debts. High ratios indicate that you are using a large portion of your income to make payments to your creditors. A 0% ratio means that you have no debt payments due.
What about Deferred Student Loans?
Such a great question! If you are considering the purchase of a home, condo or vehicle while still in school, and you have student loans in deferment (subsidized by the government or not), the potential lender may still take the amount of your debt into account during the calculations.
If the loans are in deferment, then there is no monthly payment do, so how can they include the debt? Federal Housing Authority lenders (most common sources of loans for first-time homebuyers) will assume that you will eventually have to make monthly payments on the loans equal to 2% of the total balances.
That means that if you have $50,000 in student loans, the FHA lender will add $1,000 to all other monthly debt payments you make.
Other lenders (home and vehicle) may only add 1% of your deferred debts to the calculations. Additionally, if you are a veteran and considering a VA home loan, you will add the equivalent of .417% of your deferred student loans to your monthly payments if your loans will be coming out of deferment within the next 12 months. How is that for being complicated?
Does Your College Care about Your Debt-to-Income Ratio, or Just Lenders?
Obviously, mortgage lenders will look at your DTI along with steady income and your credit rating in order to make some quick decisions as to whether to proceed to underwriting (the in-depth calculations and consideration of your loan application by the lender). The lender will add your potential monthly loan payment to the calculations, and if more than one-third of your total income is going right back out each month to the new loan and other debts, you are likely going to be considered a high-risk borrower.
Additionally, typical lenders do not like to see your new potential mortgage payment itself require more than 28% of your total monthly income. Say you work part-time and have a side business in college making $30,000 a year ($2,500 a month). Most lenders will not want to approve a mortgage if the monthly payment is going to be more than $700 (28% of $2,500) a month. No wonder it can be so difficult to become a homeowner while in college, even with regular income! $700 a month is the monthly payment of a mortgage between $120,000 and $140,000, depending upon your credit rating.
Automobile lenders will also include your debt-to-income ratio in their decision to approve any loan you apply for. While car and truck lenders will consider DTIs of a little over 1:3 (around 35% to 36%) when approving loans, we at Money Fit will rarely recommend any car or truck loan.
Look at it this way: You borrow $30,000 to buy a brand-new vehicle (assumedly worth $30,000 at the time of sale). As you drive the vehicle off the dealer’s lot, that “brand new” car or truck immediately becomes a “used” car or truck and drops anywhere from 5% to 10% in its value. At the same time that your vehicle’s value is decreasing, your debt is increasing due to the interest that you are paying on the loan. Even after paying off your vehicle in three, five or seven years, you will always pay more for the vehicle than you could get out of it by selling it. This is the very definition of a depreciating asset.
Why Your Debt-to-Income Ratio Matters Even in College
More pertinent to your college years, your DTI may play a role in the financing of your education. If, on the one hand, you only take out direct loans through the Department of Education, your credit and debt-to-income ratio have no bearing on your qualifications. Your income, does, of course, since your financial need is the determining factor in the process. On the other hand, if you ever consider taking out a private student loan, the lender will look at your income, your debt-to-income ratio, as well as your credit rating.
They may even require a co-signer (“Hi, Mom, if you’ve got a moment, I have a question for you…”). We are even less enthusiastic about private student loans than we are about car and truck loans. This mostly has to do with the lack of consumer protections on private student loans. Unlike government student loans, private student loan lenders have no obligation to offer you hardship concessions (lower payments, payment forbearance, etc.) if you were to lose your employment, go through medical emergencies or otherwise find yourself in extraordinarily tight financial spots.
How Do You Improve Your Debt-to-Income Ratio?
You only have three options to improve your debt-to-income ratio, whether you are in school or have already graduated: 1) Earn more money, 2) Pay off debts, and 3) A combination of #1 and #2
Lenders will not count income from gifts, plasma donations, and other non-earned sources. However, they can consider social security disability income if you have it.
Making larger payments than what your lenders require is the quickest way to improve your debt-to-income ratio. See our Do-It-Yourself Debt Relief series for ideas. If you are unable to make more than the minimum payment on your debts, take that as a sign you have too much debt. While in a few cases, this might result from your limited income, it is more often the case of overspending coupled with a lack of any emergency savings funds.
Pay Attention to Your Debt-to-Income Ratio even in College
Though most college students will not attempt to purchase their first home while still in school, many will seek to take out a car or truck loan before graduation. At such times, lenders will want to know the student’s debt-to-income ratio. If you are considering a car loan (which we rarely recommend), you should know your debt-to-income ratio before ever filling out a loan application. If it is already 30% or higher, you are not in a financial position to take on more debt.
Even if you are not considering a loan application, tracking your debt-to-income ratio over time will give you great insight into whether you should focus on increasing your income, paying down current debts, or both. The lower your DTI, the more financially healthy you can consider yourself.
What Is the Average Debt-to-Income Ratio for College Students?
Assuming an average credit card debt of $2,500, a $200 monthly car payment, and 15 hours a week at 150% of the minimum wage, the average student’s monthly debt payment is $280 and their average monthly gross income is around $700. $280 ÷ $700 x 100 = 40% DTI
Does Your Debt-to-Income Ratio Impact Your Student Loan Income-driven Repayment Plan?
Repayment plan eligibility relies on Adjusted Gross Income (calculate here) and the annual Federal Poverty Line for your household size in your state. Student loan interest paid can play a role. Debt balances play no role though student loan interest can.
Do Some Debts Help Your Debt-to-Income Ratio More than Others?
The type of debt has no effect on the debt-to-income formula. However, making larger payments than required for credit, store and gas cards will improve DTI faster than paying down installment loans (e.g. car) because it decreases your next monthly payment.