Your debt-to-income ratio (DTI) is a significant indicator of how much of your income goes toward your debt obligations each month. Student loan lenders utilize this ratio to calculate the borrower's interest rate and monthly student loan payment. As a borrower, it's helpful to calculate your DTI to see where your monthly debt payments stand relative to your income.
A lower debt-to-income ratio is better from the eyes of the lenders and refinancing institutions. It implies that you, as the borrower, do not need to spend a large amount of your total monthly income paying off your debts. A high debt-to-income ratio implies that you are spending more of your income on your debt obligations.
To calculate your debt-to-income ratio, start by adding up all your monthly sources of debt payments, including minimum credit card payments, home equity lines, and car loans. Once you have the total, divide this number by your monthly gross income. Finally, multiply this result by 100 to calculate your DTI as a percentage.
Our friendly DTI calculator can calculate your DTI in just a couple seconds. Let's say your monthly rent is $800, your minimum credit card payment is $75, and your monthly student loan payment is $300. Your total monthly debt payments come to a total of $1,175. So if you earn $70,000 in gross annual income, your monthly gross income would be around $5,800 so your debt-to-income ratio would be roughly 20 percent.
If you are applying to refinance your student loans or want to lower your DTI, start planning on how to do this a couple of months before applying for a new loan. Your DTI will decrease if you increase your income or reduce your monthly debt obligations.
Here are ten ways to reduce your debt-to-income ratio and potentially meet specific minimum standards to refinance your student loans in the short-term.
1. Negotiate a higher salary for your next job
Negotiating your salary is a great way to boost your income. Many companies perform annual reviews to assess an employee's performance, and those employees usually see an increase in their salary or even get a promotion. If you've made significant contributions to your company and are still waiting for your annual review, schedule a meeting with your boss. Most managers appreciate transparency and want to retain good employees.
Look for new positions to demonstrate your value or ask for new responsibilities to demonstrate your initiative. Does your company offer upward mobility? If not, maybe it's time to move on and look for a better job. We've all done that.
2. Earn extra money on the side
Have you thought about picking up a part-time job or diversifying your sources of income? You can work overtime or even take on a part-time job such as tutoring students online, building websites for customers on the weekends, or driving for Uber or Lyft. You can also look into renting out your apartment or house through Airbnb, or starting a business through Amazon FBA, for instance. The higher your monthly income (assuming your debt payments stay flat), the lower your debt-to-income ratio.
3. Cut back on unnecessary spending
Examine your current spending habits by making a list of your monthly expenses from the past six months. Feel like you're eating out too often? Maybe try cooking at home. Are you shopping a lot? Perhaps you don't need that new purse or iPhone just yet. Use that extra money to pay off your student loans or credit card debt.
4. Consolidate or pay off your credit card debt
Consolidating your credit debt is a great way to reduce your monthly payments and lower your DTI before applying to refinance your student loans.
It looks something like this. Let's assume you have four credit cards with a minimum payment of $75 each, so $300 in minimum payments each month. If you consolidate your credit card debt into a single payment, your minimum amount would only be $200. That saves you an additional $100 each month. You could then use this extra $100 to reduce your credit card debt further until most of it is paid off. Or, you could pay monthly lump-sum payments towards your student loan balance, especially if it has a higher interest rate. The Consumer Finance Protection Bureau offers solid insight into consolidating your credit cards.
5. Pay off your loans ahead of schedule
If you have extra cash to make lump-sum payments each month, you could pay off your student loan debt ahead of schedule using a couple different strategies. With the debt avalanche strategy, for example, you pay off your debt with the highest interest rate while making minimum payments on other monthly loans.
Another strategy is the debt snowball method. Borrowers pay off their smallest loans first as they steadily move their way up towards the biggest loans over time, supported by a higher income and career progression. Your DTI may increase slightly as your debt obligations increase. However, the loan balance should clear out faster, allowing for a permanent decrease in your DTI, provided that your income is steady.
6. Initiate a balance transfer to reduce your interest rate
Most of the time, a zero-interest balance transfer can help save you from significant credit card debt. However, a balance transfer could make your situation worse.
A balance transfer assigns your debt to a zero-interest credit card with a 0% APR period for a predefined period of time. During this time, you do not need to pay interest. Therefore, you could pay off the debt balance at a faster rate than before. Balance transfers may require you to have good credit or a solid current financial profile. Some banks require you to have a high credit score to approve you for a balance transfer.
7. Refinance your mortgage loan
Refinancing your mortgage on your home before applying to refinance your student loans could also help reduce your DTI. Usually, without a co-signer for a student loan, refinancing your mortgage could be easier since the lender will also look at any income your spouse brings in. You could see huge savings each year, especially if you refinance your mortgage during a period where interest rates have dropped and you refinance your student loans three to six months later.
8. Monitor your credit reports
Your credit reports offer the most fluid and up-to-date screenshot of your current financial profile. Keeping track of your credit reports helps you detect any errors on your credit report that you were previously unaware of. Sometimes, someone else's loans may end up on your credit history by accident.
Credit histories typically make up more than 30% of your overall credit score and help identify late payments. If you think you've been making payments on time, contact your lender to fix the error. Similarly, monitoring your credit reports could also help you spot fraudulent activity, which would keep your DTI in check.
9. Refinance your student loans
Once you're satisfied with your DTI or feel as if you can comfortably reduce it even further, consider refinancing your student loans. It's a great way to take off a considerable chunk out of your DTI.
The actual student loan payment itself makes up a large chunk of total monthly debt obligations for many student loan borrowers, followed by rent and mortgages. For example, a monthly loan payment of $300 could make up more than 25 percent of your total loan obligations per month. Refinancing your student loans can have an almost immediate improvement on your DTI and help you qualify for additional improvements. Before you apply to refinance your student loans, ensure that the new loan terms help you save on interest for the new loan.
10. Refinance your auto loans
Refinancing a car loan is usually easy. It lowers your interest rate or reduces your monthly loan payments, which generally allows you to walk away with more favorable loan terms.
Do you currently have a high-interest rate on your loan? Have you improved your credit score and financial profile since you purchased your car? Maybe you want the flexibility of reduced payments from a longer-maturity loan. Then, refinancing your auto loan could help reduce your DTI.
Reducing your debt-to-income ratio helps you in the long run
What's great about some of the key points listed above is that they're all interconnected in one way or the other, and knocking out one or two ways to reduce your DTI from this list helps you increase the quality of your current financial profile while being able to take on additional ways to reduce your debt-to-income ratio down the road.