It’s true that missing payments or delinquencies on your student loans can negatively affect credit scores. However, the connection between student loans and credit scores is only a small part of the equation.

For most borrowers, the biggest impact of student debt is felt in the form of Debt-to-Income ratio analysis. Essentially, the larger your monthly student loan bills, the more difficult it can be to get approved for a mortgage.

This guide will cover how student loans can impact the Debt-To-Income ratio and explore the tools and strategies that borrowers can use to reduce or eliminate the impact of student loans on mortgage applications.

Student Loans and the Debt-to-Income Ratio

The debt-to-income ratio (DTI) is one of the most critical numbers in the mortgage application process. DTI is a calculation that compares how much you owe with how much you earn every month. Lenders use it to evaluate if you can afford to pay back a mortgage.

Lenders consider two DTI numbers. The first one is called the front-end ratio. The front-end ratio looks at how the mortgage payment you’re applying for compares to your monthly income.

Calculating the front-end ratio is relatively straightforward. Lenders will look at your expected monthly housing costs – this includes the anticipated principal, interest, property taxes, and insurance – and then divide that number by your monthly income before taxes. Tools such as the FHA Mortgage Calculator are excellent for estimating housing costs.

Here’s an example of the front-end ratio at work: Suppose the total expected housing costs are $1,000 per month and the applicant earns $5,000 per month. The front-end ratio would be .20 or 20% ($1,000/$5,000). Most mortgage companies prefer a front-end ratio below 28%, though some may accept up to 31% or slightly more under certain circumstances. It’s important to note that student loans don’t impact the front-end ratio.

The second DTI number that mortgage lenders look at is called the back-end ratio. This number is the one that causes headaches for student loan borrowers. Unlike the front-end ratio that considers only the expected housing costs, the back-end ratio calculates all monthly expenses compared to monthly income. Lenders typically want this ratio to be below 41%. That said, the highest acceptable back-end ratio can vary based on your credit profile. In some cases, lenders may approve ratios even above 50%.

The back-end ratio includes the following monthly bills:

• current housing expenses
• car payments
• student loan bills
• minimum monthly payments on credit cards
• any other debt that appears on a credit report

The back-end ratio DOES NOT include the following monthly bills:

• utility bills
• food and groceries
• cell phone bill
• cable bills
• retirement plan contributions to 401(k), IRA, and Roth accounts
• most subscriptions

One final note on back-end DTI calculations: Lenders usually take yearly income and divide it by 12. If you get paid every two weeks, take your paycheck, multiply it by 26 and then divide by 12 for your monthly income.

Strategies to Improve Debt-to-Income Ratios

Fixing the back-end DTI isn’t an easy task. Most borrowers can’t just snap their fingers and have less debt. However, there are ways to tweak the DTI to lower your ratio.

Pay Down Credit Card Balances – For most types of debt, paying down the balance doesn’t change your Debt-to-Income (DTI) ratio. For instance, even if you pay more than needed on your car loan, your monthly car payment doesn’t decrease. Accordingly, your DTI remains the same. However, paying down your credit card balance lowers your minimum monthly payment. The lower your credit card balance, the less you have to pay each month. The less you’re required to pay monthly, the better your back-end DTI becomes.

Change Repayment Plans – One of the perks of federal student loans is the variety of available repayment plans. By changing to a plan like SAVE or PAYE, borrowers can potentially lower their monthly payments. Suppose a borrower has $35,000 in federal student loans and they are on the standard repayment plan. According to the federal loan repayment simulator, the monthly payment used in the DTI calculation would be $389. If that borrower switches to the graduated repayment plan, the payment lowers to $222 per month. Even though the student loan balance hasn’t changed, by switching repayment plans, the borrower can improve their back-end DTI. Many borrowers will find the lowest monthly payment using the SAVE plan.

Eliminate Smaller Balances – We’ve established that lowering the balance on most loans won’t reduce your monthly expenses. But, paying off an entire balance can make a huge difference. Typically, we suggest that borrowers pay down their highest-interest debts first. However, one notable exception is when borrowers are trying to improve their DTI for a mortgage application. By paying off a smaller loan in full, even if it is a low-interest loan, the monthly payment disappears from the credit report. Thus, one less debt means a smaller back-end DTI.

Refinancing Student Loans for Mortgage Applications

Another way to better your Debt-to-Income (DTI) ratio is by refinancing your student loans. Refinancing means finding a new lender who agrees to pay off some or all of your current student loans. You then pay back this new lender based on the terms of your new loan agreement.

People usually refinance to get a lower interest rate on their student loans. But, if you’re refinancing to help you qualify for a mortgage, the main goal is to lower your monthly payments. For example, while securing a lower interest rate is beneficial, extending the length of your loan can have a much bigger impact on reducing your monthly payments.

Please note that refinancing student loans is different than temporarily picking a new repayment plan. Before refinancing, borrowers should consider several factors:

Be Extra Careful with Federal Loans – Federal student loans have excellent borrower perks, like income-driven repayment plans and student loan forgiveness. If you refinance your federal loans with a private lender, you’ll lose access to these benefits forever. You should only refinance federal loans if you’re confident you can pay back the entire loan without needing those federal programs.

Shop Around – It’s important to compare options. Talk to several lenders because each one has their own way of evaluating loan applications. To make sure you’re getting the best deal, it’s a good idea to check rates with different lenders. We recommend applying with at least five different lenders to see what offers you can get.

Don’t Delay – The entire refinance process can easily take longer than a month. Getting approved takes time. Having your new lender pay off the old debts takes time. Waiting for your credit report to show the old loans as paid off takes time. If you are going to refinance your student loans to help your chances at a successful mortgage application, be sure to do it long before applying for the mortgage.

Find the Best Long-Term Rate – If your goal in refinancing is to lower your monthly payments for a mortgage application, opting for a longer repayment term is a smart move. For example, choosing a 20-year loan term will give you significantly lower monthly payments compared to a 10-year term. Though the interest rate might be a bit higher, your monthly payments will be much more affordable. Keep in mind that the companies advertising the lowest rates are usually promoting their shortest-term loans. Focus on the lenders who have the best 20-year refinance rates.

Multiple Refinances – As you plan your strategy, remember that there is nothing wrong with refinancing your student loans multiple times. You might start with a long-term loan to reduce your payments before applying for a mortgage, then refinance again after buying your home to lock in a better interest rate. This approach can be creative way to work within the system, but it does involve some risks. You’re counting on being approved again and lower interest rates being offered in the future.

Mortgage Applications, Student Loans, and Credit Scores

Thus far, we have focused primarily on the DTI because this is typically how student loans make the biggest impact on a mortgage application. However, student loans can also affect credit scores (which can have an effect on mortgage applications). For example, longer credit histories typically help credit scores, and a student loan might be a borrower’s oldest line of credit. Additionally, making on-time payments can improve a credit score, while late payments and other student loan issues can damage it.

The process of refinancing has the ability to either help or hurt your credit score. In the vast majority of cases, the impact on credit score is minimal in either direction. It usually is difficult to predict the exact nature of the score change. Paying off multiple loans and consolidating them into one new loan can lead to an increase in your score. But, if your student loan is one of your oldest accounts, closing it and opening a new one can shorten your credit history and might lower your score a bit.

Refinancing applications can also cause a slight dip in the credit score. Fortunately, credit agencies generally count shopping around as a single application.

For these reasons, it is crucial to make any student loan moves well in advance of your mortgage application. This will ensure that any potential negative impacts are minimal while allowing you to take advantage of the positive consequences.

There are a couple of additional items to be aware of. First, for borrowers with excellent credit scores, the minor variations from the refinance process are unlikely to impact the amount offered or the interest rate on their mortgage. Second, if your lender has mistakenly reported any negative information to the credit agencies, be sure to get this adverse reporting fixed as soon as possible.

Working with Mortgage Brokers and Lenders

Because credit scores can be complicated, it is often a good idea to consult an expert. Mortgage brokers earn their living by helping people find mortgages. Some are better than others, and some are more reputable than others. Working with someone who is not only skilled but also trustworthy can greatly improve your chances of getting approved.

A knowledgeable mortgage expert can assist most student loan borrowers in understanding their financial position and what steps they might need to take to improve their chances of mortgage approval. They can help mortgage applicants answer the following questions:

• What size mortgage will I qualify for?
• Is my credit score going to be an issue?
• What ways can I improve my DTI?
• What price range should I be considering?

Where the mortgage brokers and lenders can fall short is in helping borrowers make a responsible decision. Determining how big a mortgage someone can qualify for is one thing, but determining whether it is a good idea is another matter. Just because you can qualify for the mortgage doesn’t mean you can afford it or that it’s a good idea. Brokers get paid when new loans are created, so they don’t have an incentive to tell you when a mortgage is a bad idea.

Another area where mortgage experts can often lack expertise is with student loans. Many mortgage lenders don’t fully understand how federal repayment plans work. This knowledge deficiency can make the underwriting process more difficult.

Underwriting Issues – Can I Use IBR, PAYE, or SAVE Payments?

Mortgage underwriting is the process by which lenders evaluate an applicant’s finances to determine whether or not they should offer a mortgage loan. This process also determines the interest rate and loan size.

Borrowers who use income-driven repayment plans for their federal student loans have historically found their plans to be a hurdle in qualifying for a mortgage. In the past, lenders would not accept income-driven payments for DTI calculations because the borrower’s payments could increase. Therefore, they concluded that the payments weren’t an accurate representation of that monthly expense.

Student loan borrowers and advocates argued that the only reason these payments would go up is if the borrower was earning more money. Borrowers making more money would be in a better position to repay their mortgage.

Nonetheless, for years, borrowers weren’t able to use income-driven payments for DTI calculations. Instead, lenders would replace the actual monthly payment with 1% of the loan balance. For borrowers with enormous debts, this would often shatter the DTI and lead to application rejections.

The good news is that most lenders are becoming more knowledgeable on this issue.

Mortgage giants like Freddie Mac and Fannie Mae have finally seen the light. They have updated their approach and are now more open to considering payments under income-driven repayment plans (like IBR, PAYE, or SAVE) when calculating your DTI. This new approach has also been adopted by many smaller lenders, like local credit unions and regional banks. However, not every lender is on board with including these types of payments into DTI calculations. For this reason, it is critical to communicate with your lender to determine how they evaluate income-driven payments on student loan applications.

To safeguard your home buying journey, we recommend applying for a mortgage with multiple lenders. This way, if one lender gets cold feet about your student debt close to the final decision, you’ll have another option already in progress.

Sherpa Tip: For many borrowers, the plan with the lowest monthly payment is the best plan to use if you are going to apply for a mortgage.

Special Rules for $0 Payments on Mortgage Applications

When applying for a mortgage, it’s important to understand that mortgage lenders typically do not consider $0 payments when calculating debt-to-income (DTI) ratios. Instead, they use a percentage of the existing loan balance. Historically, lenders used a flat 1% of the loan balance for these calculations. However, many lenders now use a more favorable 0.5% rate.

If you qualify for a $0 per month payment on your student loans, it may be beneficial to switch to a repayment plan that offers the lowest non-zero monthly payment. This strategy can present a more favorable DTI ratio to lenders, potentially improving your mortgage approval chances.

However, there are significant drawbacks to consider. Switching to a plan with a higher payment means spending more money on your student loans. Additionally, if you move away from an income-driven repayment (IDR) plan, you could lose valuable time toward student loan forgiveness. The process of changing repayment plans can also be cumbersome and time-consuming.

If you decide to change repayment plans for mortgage purposes, it is advisable to make the switch a few months before applying for the mortgage. This timing ensures that the new monthly payment appears on your credit report. Maintaining this mortgage-friendly payment plan until the loan closes is wise, as lenders may conduct another credit check at that point. After closing on the house, you can switch back to the plan offering a $0 per month payment, assuming you still qualify.

Given the complexities involved in tweaking repayment plans and mortgage eligibility, consulting with several mortgage professionals is a prudent step. Explain your available repayment plans and discuss your options. While the extra steps of changing repayment plans may not be necessary in every case, for those with substantial student loan balances, it could be the key to securing the mortgage you want.

Co-Signer Issues on Mortgage Applications

Being a co-signer on a student loan can also impact your mortgage application. Co-signed student loans appear on your credit report, along with monthly payments. Consequently, most lenders include the co-signed loan payment in DTI calculations, even if you aren’t the one who makes the student loan payments.

Many lenders will remove the co-signed loan from the DTI calculation if you can show that the student loan borrower has been making payments independently for a while, usually 12 to 24 months. However, since many mortgage applications are initially reviewed by a computer algorithm, co-signed loans could still trigger a rejection, regardless of the primary borrower’s payment history.

Things get further complicated for co-signers of borrowers still in school. We have heard of lenders going so far as to initiate a three-way call between the mortgage applicant, the mortgage company, and the student loan company. The mortgage company essentially asks the student loan company to determine the maximum potential payment once the borrower graduates and enters repayment. This maximum payment is then used in the DTI calculations, potentially affecting the co-signer’s mortgage application significantly.

Accordingly, if you’re thinking about buying a house in the future, you should probably avoid co-signing on student loans if possible.

Next Steps to Fix Student Loan Debt on Your Mortgage Application and Buy a Home

The following steps could help you qualify for a home loan. Because student loan changes can take months to be reflected in your credit report, you should plan ahead.

Visit the Federal Repayment Simulator – Review the repayment plan options to get the lowest monthly payment.

Refinance Private Loans – The best way to improve debt-to-income ratios for private loan debt is to pick a 20-year loan at the lowest interest rate possible. Borrowers can probably refinance again after securing a mortgage.

Try to get a Co-Signer Release – If you have co-signed a student loan for someone else, getting removed from that loan should be a priority.

The post Student Loans and Mortgages: The Impacts and Strategies for Homebuyers appeared first on The Student Loan Sherpa.

If the borrower misses a deadline or makes a mistake, the cosigned loan can hurt the cosigner’s credit score.

Unfortunately for cosigners, DTI and credit score are the two most important factors creditors use when evaluating mortgage, car loan, and credit card applications.

Today we will examine how cosigned student loans impact the cosigner’s credit score and DTI. We will also look at some strategies to minimize or eliminate this impact.

Cosigned Debt is Your Debt

In most cases, lenders and creditors will treat cosigned debt as your debt when evaluating applications.

Your credit report shows a total balance, monthly payment amount, and repayment history. In some cases, it doesn’t show that the loan is cosigned or that the cosigner is not the principal borrower.

Why?

Lenders don’t care. As far as a potential creditor is concerned, you may have to start making payments on the debt. In most cases, they assume that you will be making payments on the debt.

Because almost all lending decisions are made using an automated computer algorithm, cosigners don’t get to explain themselves or demonstrate that the primary borrower is responsible and able to make payments.

One Possible Exception: Some mortgage lenders will exclude cosigned debt from mortgage applications. However, the cosigner usually must show that the primary borrower can make payments independently and has been doing so for at least a year.

If the primary borrower is still in school or on a deferment, the cosigned debt will almost certainly be treated as the cosigner’s own debt.

Debt-to-Income Ratio (DTI) Damage from Cosigned Loans

Because most cosigned loans are “counted against” the cosigner, the most common negative consequence is that it hurts the cosigner’s debt-to-income ratio, usually shortened to DTI.

An applicant’s DTI is critical when applying for a mortgage, car loan, or credit card. Lenders often deny applications if the high monthly bills on your credit report eat up a large portion of your yearly income.

For example, mortgage lenders like to see a DTI below 41%. If you have a modest income and cosign large student loans, getting approved for a home loan will be tough.

Credit Score Risk Only Impacts Some Cosigners

Things are a little less bleak on the credit score side of the equation.

The big risk to a cosigner’s credit score is if the borrower fails to make payments.

If the borrower doesn’t make payments on the cosigned loan, the cosigner has two options:

1. Start making payments on behalf of the cosigner.
2. Live with the damaged credit score and other fallout from failing to make payments on the loan.

It’s worth noting that the cosigner is legally obligated to pay if the borrower fails to make payments. The credit score damage is just the beginning of the issues if the payment is unaffordable for both the borrower and the cosigner.

Removing Cosigners Can Fix DTI and Credit Score Issues

Given all of the risks with a cosigned loan, it isn’t a surprise that many cosigners want to be removed from the loan.

Some lenders even advertise a cosigner release program to entice people to use their services. Sadly, the cosigner release programs are more myth than reality, according to the Consumer Financial Protection Bureau.

Lenders have every incentive to deny the release application. If they grant the release, they only have one person legally responsible for the loan. For this reason, many lenders require the primary borrower to have made at least a year of payments AND pass an additional credit check.

However, if the borrower has a great interest rate on their loan and has built up a strong payment and credit history, seeking a release is a worthwhile effort.

Once the cosigner release is granted, the debt falls off the cosigner’s credit report, solving the DTI issue and preventing future credit score problems.

Cosigner Release Guide: A cosigner release isn’t the only way to remove a cosigner from a loan. Several other strategies are available to remove the debt from the cosigner’s credit report.

Steps When Cosigner Removal Isn’t an Option

If the lender won’t approve the cosigner release, refinancing the debt is a commonly used shortcut.

The process is relatively simple: The borrower applies to refinance their private student loan. If approved, the new lender pays off the old loan, and the borrower begins repayment on a new loan with new terms.

If the cosigner isn’t on the new loan application, they are free from the debt.

Steps to Take if the Borrower Can’t Qualify to Refinance

The refinance option is great when the primary borrower has finished school and begun loan repayment. Refinancing will be much more complicated if the borrower is still in school or struggling financially.

In this instance, cosigning a second time could make sense.

By going this route, the cosigner’s legal responsibility hasn’t changed. However, refinancing might offer lower payments and/or a lower interest rate.

If the refinanced loan has a dramatically reduced monthly payment, the damage to the cosigner’s DTI is likewise reduced. For example, refinancing a 5-year loan into a 20-year loan could result in significantly lower monthly payments.

The downside is that interest spending may increase. However, the borrower can still pay extra to pay off the loan as initially planned; they just have the flexibility of a lower monthly payment.

As the primary borrower’s finances improve, they could refinance a second time to remove the cosigner completely.

As of November 2024, the following lenders advertise the lowest interest rates for 20-year fixed-rate refinance loans:

Rank	Lender	Lowest Rate	Sherpa Review
1		6.08%*	Splash Financial Review
2		6.53%	ELFI Review
3		6.55%	Laurel Road Review

The post How Cosigned Loans Can Wreck Your DTI and Credit Score appeared first on The Student Loan Sherpa.

In order to sort out this issue, we reached out to a number of student loan refinance companies to inquire about their DTI requirements. Many were not willing to share specific DTI requirements, but we received enough responses to have a pretty good idea about what most lenders require.

Debt-to-Income Ratio Basics

An applicant’s debt-to-income ratio is their total monthly debt payments divided by their total gross income.

To calculate your DTI, first add up all of your monthly debts as they appear on your credit report.

These monthly debts can include:

• Mortgage or rent payments
• Minimum payments for credit cards
• Car loans
• Student loans
• Personal loans
• Alimony and child support
• Any other debt that shows up on your credit report

Gross income is your total monthly salary before taxes and other deductions.

Typically DTI is expressed as a percentage. If your total monthly debts add up to $2,000 and your monthly income is $5,000, your DTI will be 40% (2,000 divided by 5,000 equals .40). If you don’t want to do the basic math, a simple calculator can be found here.

Items Not Included in DTI Calculations

The term “monthly expenses” can be a bit misleading.

Getting a bill each month does not make an expense a “monthly expense” for purposes of DTI calculations. The important detail is whether or not the payment appears on the applicant’s credit report.

Thus, many common monthly expenses know in DTI calculations.

The following are unlikely to affect your DTI:

• Grocery bills
• Cell phone bills
• Insurance expenses
• Utilities and cable
• Taxes
• Netflix, hulu, and other streaming services
• Subscription and software services like Spotify or Microsoft Office

In other words, if the bill doesn’t appear on your credit report and a lender doesn’t ask about it, an expense is unlikely to be included in your DTI.

Refinance Lender Debt-to-Income Ratio Requirements

Before jumping into specific numbers, we should point out that DTI calculations and requirements are not an exact science. Your DTI may go up or down depending upon the credit bureau a lender checks. Your credit score can also have an impact on the DTI a lender will accept. If your credit score is excellent, a lender may tolerate a higher DTI. If you have a cosigner, a lender may accept a higher DTI.

When we surveyed the refinance lenders, we were able to learn the following:

Lender	Maximum DTI	Lender Application
	65%	Application
	55%	Application + $150 Bonus
	50%	Application
	33 – 50%	Application + $150 Bonus

Earnest having the highest acceptable DTI is not a surprise because they ask for the most financial information from applicants. If your finances are strong despite a high DTI, Earnest may be a good bet for approval.

Other lenders required a DTI right around 50%. We suspect that the lenders that responded to our survey are the ones with the more borrower-friendly DTI requirements. Refinance companies want to encourage people to apply, and those with strict DTI requirements are probably less likely to share that information. Thus, borrowers looking to refinance their student loans but concerned about their DTI should strongly consider the companies listed above.

Improving Your DTI

If you have run the numbers and your DTI looks ugly, there is still hope.

There are several ways to improve a DTI without having to spend a ton of money.

Pay down credit card balances – Reducing most balances does not help your DTI. If your mortgage payment is $1,100 per month, paying extra towards your mortgage each month will not change the payment or your DTI. Credit cards are a notable exception. The lower your credit card balance, the lower your minimum payment will be. If you can pay a little extra towards your credit card debt, you can improve your DTI.

Change repayment plans – Federal student loans show up on your credit report. Changing repayment plans can cause the loan servicers to report a lower monthly payment. If you are on the standard repayment plan, consider switching to an income-driven repayment plan. You can estimate monthly payments on the various repayment plans with the Department of Education’s Repayment Estimator.

Get released as a co-signer – Debt you have co-signed is a gray area for DTI calculations. Some lenders will allow applicants to submit documentation showing that the named borrower is making payments, but this is far from a sure thing. Because most approval decisions are made automatically by a computer, you should assume that co-signed loans will be included. If you can get released as a co-signer on someone else’s debt, it will help your DTI.

Make sure your credit report is accurate – If there is a mistake on your credit report, it could be showing debt that is not your responsibility. Be sure to take a close look at your credit report to find any errors. If there is an error, work with the credit bureaus to get it removed before applying to refinance your student loans.

Wait for old debts to fall off – Did you just pay off your car? Have you finally eliminated a credit card? These items do not immediately fall off a credit report. It can take a month or two before the debt that has been paid in full is removed from a credit report.

Final Thoughts on Debt-to-Income Ratios

Navigating DTIs in search of a student loan refinance approval is not an exact science. Each lender uses a slightly different formula, and depending upon your credit score, the maximum acceptable DTI could vary.

The important thing to understand is that debt-to-income ratios are one of the most important numbers for any credit application. If you understand how it works, you can find ways to improve your DTI.

The post Debt-to-Income Ratios Needed for Student Loan Refinancing appeared first on The Student Loan Sherpa.

The possible fees and costs of a student loan refinance include losing out on federal protections like student loan forgiveness, increasing interest rates, difficulty buying a house, and a higher tax bill.

Making things even more dangerous is the fact that there is no way to “undo” a student loan refinance. Once the refinance lender creates a new loan and pays off the old loans, there is no going back. Before getting started with a student loan refinance, all borrowers should seriously consider the costs of the process. Borrowers that do their research can avoid most or all of the hidden costs of student loan refinancing.

Loss of Federal Perks and Protections

The most significant risk to the student loan refinance process applies only to borrowers who decide to refinance their federal loans.

All federal loans come with borrower protections like income-driven repayment plans and student loan forgiveness. Borrowers who lose their job or experience a reduction in salary can get their monthly payments lowered based upon what they earn rather than what they owe. This means a borrower with $100,000 in student loans could have a monthly payment as low as $0 per month.

Refinancing federal loans means the old federal loans are paid off in full and a new private loan is created. The advantage for borrowers is the lower interest rates that may be available; the downside is that the federal perks are forever gone.

Borrowers who feel they might need the protections offered by federal loans would be wise to only refinance their private loans.

Increasing Interest Rates on Variable-Rate Refinance Loans

The lowest rates available from refinancing lenders are almost always variable-rate loans. However, during times of high interest rates in the economy and inflation, fixed-rate loans will occassionally offer lower rates.

As economic conditions change, the interest rates on a variable-rate loan will also change. This change could be for the better or for the worse.

For this reason, borrowers would be wise to focus on fixed-rate refinancing, especially for those seeking longer loan terms. Should refinance rates drop in the future, borrowers can always refinance a second time with a new fixed-rate loan.

Origination and Prepayment Fees

This site has been tracking student loan refinance lenders for years.

During that time, loan origination fees and prepayment fees have almost entirely been eliminated from the marketplace. Lenders that tried to add an origination fee were criticized, and borrowers steered clear. At present, loan origination fees are only used by some lenders for in-school loans.

Despite the positive changes for consumers, there is always the danger that new lenders could enter the scene and charge an origination fee. As a result, borrowers should carefully read any contract for a fee that could be hidden in the fine print.

Debt-To-Income (DTI) Ratio Concerns

The Debt-To-Income Ratio, or DTI, is a number that creditors look at when evaluating applications. The DTI compares an applicant’s monthly income against their monthly debt.

Generally speaking, student loan refinancing is a useful tool for improving a borrower’s DTI. However, in some instances, a refinance can hurt the borrower’s DTI. Negative changes to DTI could make it harder to qualify for a mortgage or auto loan in the future.

There are two potentially negative consequences that borrowers should consider:

Increased Monthly Payments – Many borrowers choose to refinance their student loans on a 5-year repayment plan. The 5-year loan terms have the lowest rates available. The danger in this route is that the minimum monthly payment needs to be quite large to pay the debt in full. Thus, the short repayment plan means much lower interest rates but higher monthly payments. While this is a great way to eliminate debt, it can make qualifying for a mortgage harder. Borrowers who may be considering buying a home in the future should focus on longer repayment lengths to keep their minimum monthly payments lower.

Cosigner Concerns – Some borrowers choose to have a cosigner on their refinance loan to help their chances of approval. Cosigners who were not on the original loans will have new debt added to their credit report. Even if the primary borrower is making payments on time, cosigners can still face negative consequences for being on the loan because cosigned loans are often included in DTI calculations by creditors. If the cosigner was on the original loan, and the new monthly payment is lower, the refinance can help the cosigner. If the cosigner was on the original loan and not included on the new loan, the refinance is a great way to get a cosigner release.

Tax Deductions Issues

One way the government helps with student loan repayment is in the form of a tax deduction.

The student loan tax deduction applies only to interest paid. Payments towards loan principal are not included in the deduction. Borrowers can deduct up to $2,500 of student loan interest payments. (Note: A $2,500 deduction does not mean $2,500 less on taxes; it means the government taxes the borrower as if they earned $2,500 less that year.)

Due to the limitations of the student loan interest tax deduction, it isn’t a huge break for most borrowers, but it can still be worth several hundred dollars each April.

Refinancing student debt can affect this deduction in two ways:

Refinance with a Personal Loan – Nearly all student loan refinance companies refinance student loans with a new loan that qualifies for the deduction. However, some borrowers choose to refinance their student loans with a personal loan. This approach is usually a mistake because it often results in higher interest rates and borrowers loose the ability to claim the student loan interest deduction.

Less Spent on Interest – Put this in the category of technically true but not a “concern” to be worried about. The idea behind refinancing is to save money on interest. Spending less on interest means potentially getting less of a deduction. That being said, avoiding a refinance to keep interest rates high to maximize a deduction would be a huge mistake.

Due to the nature of the deduction, the value of saving money on student loan interest will always exceed any potential deduction of student loan interest from taxes.

Final Thoughts

Consumers looking to refinance student loans are much savvier than most in-school student loan borrowers. Repaying student debt tends to make people more careful with future student loan contracts. As a result, lenders seem to realize they can’t get away with nonsense fees and expenses.

Refinancing remains a substantial financial decision due to the massive amounts of money changing hands. Borrowers should carefully consider all of the potential consequences before actually refinancing their loans.

Borrowers who decide that refinancing is right for their situation should invest an hour or two to shop around to find the best interest rates possible. Each lender uses a different formula for evaluating applications and determining the rate the lender will offer.

The entire purpose of the process is to save money on interest, and the only way to know which lender has the best rate is to check…

Pros:	SoFi is the biggest name in student loan refinancing for a simple reason – their rates are reliably among the best on the market.	LendKey works with a large network of smaller credit unions and banks. As a result, many applicants get the best offer from LendKey.	Splash has the best new customer bonus right now, and they have excellent rates and term opitons.
Cons:	SoFi has grown into a large company offering mortgages, personal loans, and investment services. They no longer focus entirely on student loan refinancing.	Going the LendKey route does require working with a local bank or credit union. For many, this is a plus, but it is an extra step.	Splash is a newer lender and getting approval may be more difficult for some borrowers.
Bonus:	NA	$150	Up to $500

The post Hidden Fees and Costs of Student Loan Refinancing appeared first on The Student Loan Sherpa.

On many rejection letters, creditors will simply say the denial was due to insufficient income or because the debt relative to the income was too high. Today we will discuss how the debt-to-income ratio or DTI works, and how it can be improved in a short period of time.

Debt-to-income ratio basics and calculations

When a creditor checks your debt-to-income ratio they are looking at your monthly income and comparing it to the monthly bills that show up on your credit report.

Debt-to-income ratio includes the following:

• Monthly mortgage payments
• Minimum amount due on your credit card
• Monthly car payments
• Minimum due on each student loan
• The minimum due on any other open lines of credit

Debt-to-income ratio does not include the following:

• Cell phone bills
• Utilities
• Cable bills
• Insurance costs

Creditors normally treat the debt-to-income ratio as a percentage. If your monthly debt accounts for half of your income each month, your debt to income ratio is 50%.

On most credit applications, potential lenders will not provide an actual debt-to-income ratio. Instead, they will simply say that your debt is too high relative to your income if the debt-to-income ratio is the basis for a denial.

Debt-to-income ratio issues

Student loans are a specific source of trouble for many borrowers looking for lender approval. If a loan is in forbearance or deferment, the credit report may not show what the expected monthly payment will be. Some lenders will deny an application on this fact alone. Others will use a certain percentage of the loan balance for use in the calculation.

Mortgage companies can also be really picky when it comes to federal loans and calculating your debt-to-income ratio. In many circumstances, they will just use the monthly payment, or 1% of the loan balance, whichever is greater, for making the calculation. If you are on an income-driven repayment plan and applying for a mortgage, this could be a very serious issue. We previously covered this problem in more detail.

Improving your debt-to-income ratio

Fixing this ratio can be an expensive task. It is complicated by the fact that some payments lower your debt-to-income ratio while others have no change. For example, a large payment towards your credit card debt will reduce your minimum monthly payment and improve your ratio. However, paying off a large portion of a car loan will not change your monthly bill and as a result, the debt-to-income ratio remains the same.

The best way to improve things is to target debts that you can eliminate entirely. If you have a student loan with a smaller balance that you can pay off in full, it will help your debt-to-income ratio. Paying off half of a very large loan will have no impact.

Another way to improve things would be to refinance your student loans. Lenders like SoFi and LendKey can potentially offer lower interest rates, and repayment plans up to 20 years (though the longer repayment plans typically come with higher interest rates). If you can lock in a lower interest rate and longer repayment plan, you can dramatically reduce your monthly payments on your student loans. This can free up extra cash each month for your higher interest debt and improve your debt-to-income ratio.

Creating a plan

Turning a rejection due to insufficient income requires some serious planning. You will need to figure out exactly which loans you are going to attack and get them paid off entirely. It is also important to pay attention to the reporting policy of the creditor. Paying off the loan isn’t enough. The zero balance needs to show up on your credit report. Once you have reduced your monthly debts according to your credit report, you will be in a much better position to get an approval.

Next steps

• Focus on paying down credit card balances.
• Use the Federal Student Loan Simulator to explore options to get lower monthly payments on your federal student loans.
• Investigate student loan refinance companies offering lower interest rates.

The post Student Loans and Your Debt-To-Income Ratio appeared first on The Student Loan Sherpa.

Credit cards are a little different. With just a little bit of effort, most people can tweak their credit card situation so that it helps their refinance efforts.

One of our readers had this question in mind when he wrote the following:

Hello,
I am interested in refinancing my student loans, but I heard that it would be in my best interest as far as interest rates go to reduce the available credit I have on my credit cards. Is this true? How does this work?

Best,
Jeff

Jeff is right and wrong. The available credit does make a difference in your application, but reducing it will only make things worse.

Understanding Debt-to-Income

There are a number of different factors that go into any credit approval or rejection decision.

Along with your credit score, one of the most important factors is your monthly debt-to-income ratio.

The debt-to-income ratio is how lenders determine your ability to pay. The more income you have each month, or the less debt you have, the better this number gets. If your monthly debt bills are low compared to your monthly income, your odds of approval are much better.

Credit Cards and Debt-to-Income

Whether you carry a balance or pay off your credit card in full each month, your credit card affects your debt-to-income ratio.

The key number with the credit card is the minimum amount due. This is the number that the computers will use when they do the math on your debt-to-income ratio.

Even if you are paying your credit card balance in full each month, you will note that there is still a minimum payment. You might also notice that as your balance gets lower, the minimum due gets lower. Keeping that number as low as possible will help your cause.

Credit Cards and your Credit Score

You may be thinking that if you just cancel your credit card, the minimum payment becomes zero.

While this is true, doing so will likely hurt your credit score, so it is best not to cancel the card. When lenders look at your credit report, having a credit card, paying your bills each month, and keeping the balance low will help your credit score greatly.

Another factor that goes into your credit score, as noted by Jeff, is your available credit. Lenders what to see a lot of available credit. This shows that you can resist the impulse to just max out your credit cards.

Most credit experts suggest that you use no more than 30% of your available credit, while others say that below 10% is best. The key number is the monthly statement. Even if you use the credit card well above the 30% available credit, if you pay off the debt before the credit card company issues the statement, it will show a very low balance and a high available credit.

This move will help your application numbers. If you have been with your credit card company a while, you might also consider calling to ask them to raise your limit (just make sure they don’t need to do a credit pull in order to do so). Even if you don’t ever plan on using the extra available credit, having it will help your credit score.

Your Timeline

One other thing to keep in mind is that the student loan refinance lenders do not have direct contact with your credit card companies. They get this information from the credit agencies.

The credit agencies get monthly updates from your credit card companies. That means that knocking down your credit card balance will not help you if you apply to refinance tomorrow.

You have to give the companies involved time to update the necessary information. The best practice would be to keep balances low for at least a couple of months. Going this route assures you that the numbers reported are good ones.

The Bottom Line

Getting your credit cards in order before you apply to refinance can really help your application odds of success.

The key is keeping your balance low and available credit high. Do this, and you give yourself the best chances at approval.

The post Credit Card Debt and Student Loan Refinance Applications appeared first on The Student Loan Sherpa.