How Your Debt-to-Income Ratio Affects Student Loan Refinancing

The debt-to-income ratio (DTI) is an important indicator of your ability to pay your financial obligations. It’s calculated by dividing your monthly debt payments by your gross monthly income. A high DTI signifies you may be more at risk of missing payments.

Student loan refinancing can help you simplify your loan repayment plan and possibly save money on interest charges. But to get approved, you must meet the private lender’s eligibility criteria, which typically includes a maximum DTI.  

Understanding how your debt-to-income impacts your student loan refinance options can help you determine the best approach to getting approved with favorable terms. 

How debt-to-income ratio impacts student loan refinance

When you apply for a private student refinance loan, the lender will evaluate your creditworthiness to determine whether or not you’re eligible. 

Your DTI ratio is one of the most important factors lenders consider because it gives the lender insight into your ability to make monthly payments. Here are some factors DTI affects:

• Eligibility: Lenders typically set a maximum DTI threshold—often 50%. If yours is too high, you may not qualify for a loan, even with great credit. Also, consider your DTI from a quality-of-life perspective—overall, you want to be closer to 35%.
• Interest rates: Student loan refinance lenders typically offer a range of interest rates. If your DTI is on the high end of what the lender will accept, the lender may charge you a higher interest rate because you’re more at risk of becoming delinquent on your payments.
• Repayment terms: Student loan refinance repayment terms can be anywhere from five to 20 years, depending on the lender. However, not all terms are available to all borrowers. Lenders will offer you a term based on your creditworthiness, which incorporates your DTI and your loan balance.
• Your need for a cosigner: If you can’t get approved on your own or qualify for decent terms because your DTI is too high, you may need a cosigner to improve your odds.

Remember, though, that your DTI is just one of many factors lenders will consider when you apply for a refinance loan. They’ll also review your credit score, credit history, income, and other details of your financial situation.

If you have federal student loans, note that your ability to consolidate your loans through the Direct Loan Consolidation program won’t be impacted by your DTI or credit score. While you can refinance federal loans with a private lender, carefully consider the benefits and drawbacks before you proceed.

What is the maximum DTI you can have to refinance student loans?

Each lender has its approach to underwriting student loan refinance applications, so there’s no universal DTI requirement. Student loan refinance lenders typically don’t disclose their maximum DTI thresholds publicly.

However, most experts recommend keeping your DTI below the 50% threshold to have a good chance of approval.

The good news is that most student refinance lenders allow you to prequalify before you submit an official application. Prequalification utilizes a soft credit check, which doesn’t impact your credit, and can give you a good idea of your eligibility and loan terms.

It’s best to get prequalified with multiple lenders to compare your offers. Keep a spreadsheet with all the lenders and offers so you can compare everything in one place. Depending on what you get, you can decide whether to get a cosigner, work on decreasing your DTI, or improve other aspects of your creditworthiness.

Ask the expert

Crystal Rau

CFP®

I prefer that the DTI ratio be closer to 35% for all of your debt, including a mortgage. Anything higher than that will start to affect your quality of life. You’ll have less to spend on the things you want to spend on, like dining out and vacations, because the majority of your income is going to service debt payments.

How to calculate your DTI

The debt-to-income ratio calculation is simple: divide your monthly debt payments by your gross monthly income. If paid monthly, take the gross amount before taxes and other deductions for your monthly income. If you’re paid semi-monthly, multiply your gross pay by two.

But in other situations, the process may be a bit more complicated than that:

• You’re paid weekly or biweekly: Because some months have more weeks than others, your earnings may not be the same every month. If that’s the case, divide your annual income by 12 to get your gross monthly income.
• You work varying hours: If you don’t have a consistent number of hours, divide annual pay from the previous year by 12. If your hourly wage has changed since last year, take your average gross income from the last three to six months.
• You’re self-employed: If you’re self-employed, take your average gross income (not your business revenues) from the past two tax returns and divide it by 12. If your business is new and you don’t have two years’ worth of tax returns, you may not be eligible for refinancing.

As an example, suppose you earn $5,000 per month before taxes and have the following debt payments:

• Mortgage: $1,200
• Auto loan: $450
• Student loans: $375
• Credit cards: $250

In total, you have $2,275 in monthly debt payments. Dividing that figure by $5,000 gives you a DTI of 45.5%. While that’s below the recommended 50% threshold, a lender with a lower maximum may not approve your application without a cosigner. 

Even if you qualify, paying down some of your debt to reduce your DTI before applying may make sense.

What if my DTI is too high to refinance student loans?

If your DTI is on the high end, here are some steps you can take to improve your odds of getting approved.

Apply with a cosigner

How it works: When someone cosigns your application, they agree to pay the debt if you can’t. As a result, the lender will consider both your and your cosigner’s creditworthiness to decide.

What to know: Your cosigner must also meet the lender’s other credit and income requirements. While some lenders allow you to release a cosigner after meeting certain requirements, getting approved can be difficult.

Finally, ensure your cosigner understands that the loan will also show up on their credit history, which can impact their ability to obtain credit, especially if you miss a payment.

Pay off a small balance  

How it works: If you have a small loan or credit card balance, paying it off will remove that monthly payment from your DTI calculation, which can decrease your ratio.

What to know: It can take a month or longer for lenders to report a payment, so check with the lender to see if you can provide a payoff confirmation as proof that the payment is no longer necessary.

Also, remember that minimum credit card payments will be listed on your credit reports even if you pay your balance in full on time. Avoid using your credit cards for a few months if you don’t want them included.

Improve other aspects of your creditworthiness

How it works: Because lenders consider various factors to determine your eligibility and loan terms, improving your credit score can help counteract some of the negative impact of a higher DTI if your ratio doesn’t exceed the lender’s maximum.

What to know: Increasing your credit score can take several months. Check your credit score with a free service like annualcreditreport.com to get an idea of where you stand, and review your credit reports to identify which areas you can address. Then, continue to monitor your credit score so you can track your progress.