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The Importance of a Good Debt to Income (DTI) Ratio

November 15, 2019

It is evident to most people that having more income and less debt is good for their finances. If you have too much debt compared to income, any shock to your income level could mean you end up with unsustainable levels of debt. Every month you have money coming in (your salary plus additional income) and money going out (your expenses). Your expenses include your recurring bills for electricity, your cell phone, the internet, etc. There are also regular amounts that you spend on necessities, such as groceries or transportation. On top of all of this, there’s the money you spend to service any debts that you may have. These debts could include your mortgage, rent, car loan, and any student loans, personal loans, or credit card debt.

 

What is the Debt-to-Income Ratio (DTI)?

The Debt-to-Income Ratio (DTI) lets you see how your total monthly debt relates to your gross monthly income. Your gross monthly income is your total income from all sources before taxes and other deductions are taken out. Below is the formula for calculating your DTI:

DTI = (Total of your monthly debt payments/your gross monthly income) x 100

 

Example: Let’s suppose the following. Your gross monthly income is $5,000, and you pay $1,500 a month to cover your mortgage, plus $350 a month for your student loans, and you have no other debt. Your total monthly payments to cover your debts amounts to $1,850.

 

Your DTI is (1,850/5,000) x 100 = 37%

Here’s a handy calculator to work out your DTI.

 

Why is Your DTI Important?

Your DTI is an important number to keep an eye on because it tells you whether your financial situation is good or if it is precarious. If your DTI is high, 60% for example, any blow to your income will leave you struggling to pay down your debt. If you are hit with some unexpected expenses (e.g., medical bills or your car needs expensive repairs), it will be harder for you to keep on top of your debt payments than if your DTI was only 25%.

 

DTI and Your Credit Risk

DTI is typically used within the lending industry. If you apply for a loan, a lender will look at your DTI as an important measure of risk. If you have a high DTI, you will be regarded as more likely to default on a loan. If you apply for a mortgage, your DTI will be calculated as part of the underwriting process. Usually, 43% is the highest DTI you can have and likely receive a Qualified Mortgage. (A Qualified Mortgage is a preferred type of mortgage because it comes with more protections for the borrower, e.g., limits on fees.)

 

So, What is a Good DTI?

If 43% is the top level DTI necessary to obtain a Qualified Mortgage, what is a “good” DTI? According to NerdWallet, a DTI of 20% or below is low. A DTI of 40% or more is an indication of financial stress. So, a good rule of thumb is that a good DTI should be between these two figures, and the lower, the better. 

 

The DTI Bottom Line

Your DTI is an essential measure of your financial security. The higher the number, the less likely it is that you’ll be unable to pay down your debt. If there are months when it seems that all your money is going toward debt payments, then your DTI is probably too high. With a low DTI, you will be able to weather any financial storms and maybe even take some risks. For example, if you want to take a job in a field you’ve always dreamed about but are hesitating because it pays less, it will be easier to adjust to a lower income. Plus, debt equals stress. The higher your DTI, the more you can begin to feel that you’re working just to pay off your creditors, and no one wants that.

 

DTI and Student Loan Refinancing

Your DTI is one of several factors that lenders look at if you apply to refinance your student loans. They may also assess your credit history, employment record, and savings. Refinancing your student loans may actually decrease your DTI by lowering your monthly student loan payment. This may help you, for example, if you want to apply for a mortgage. ELFI can help you figure out what your DTI is and if you are a good candidate for student loan refinancing. Give us a call today at 1.844.601.ELFI.

 

Learn More About Student Loan Refinancing

 

Terms and conditions apply. Subject to credit approval.

 

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Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – The bank is not responsible for the content. Please contact us with any concerns or comments.

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2020-02-12
What the New FICO Score Changes Mean For You

Are you apartment hunting, trying to refinance your student loans or thinking of applying for a new credit card? If you ever needed the motivation to care about your credit score, this is it. Your FICO score is going to be an important factor when trying to do any of those things. Recently, Fair, Isaac, and Company, the company behind FICO, announced that changes will be made to how the score is calculated. Keep reading to find out about the changes and what they could mean for your FICO score. 

 

What is a FICO score?

The FICO score is a scale used to determine a person’s creditworthiness or risk. The score is used by potential lenders, such as banks and credit card companies. A FICO score ranges from 300 to 850, with a score of 700 or higher being considered good. A score of 800 or higher is considered exceptional. The average FICO score in 2019 was 703. 

 

A person with a higher score is regarded as being less risky to lend to than a person with a lower score. Your FICO score can determine whether lenders will lend to you, as well as the terms of the loan, such as your interest rate. The interest rate on credit cards, student loans, car loans, and mortgages are all affected by your credit score. A higher interest rate can sometimes cost you thousands of dollars more over the life of a loan. A FICO score may also be considered when applying to rent an apartment – for example, a low score may require you to pay a higher deposit.  

 

A FICO score is determined by assessing the following, among other factors:

  • A person’s payment history
  • How much debt a person has compared to how much available credit they have
  • The total amount of debt a person has or their debt-to-income ratio
  • The length of credit history

Typically, if you maintain a debt-to-income ratio of 30% or less and make on-time payments to your credit cards and loans, you can work towards a high score. If you’re ready to start improving your credit score now, check out our good credit-building guide.

 

New FICO Score Changes

The new changes coming to FICO are known as FICO 10 and are set to go into effect in the summer of 2020. They include:  

  1. Lenders will be able to look at payment history two years back as well as account balances. This will demonstrate to lenders whether you are an occasional credit user or someone who consistently maxes out credit and hardly makes payments back.  
  2. It will be noted if a person is taking out personal loans, and this could potentially negatively impact a person’s credit score. Personal loans may be considered riskier since they are unsecured loans, unlike mortgages and auto loans where your asset is the collateral for the loan.  
  3. Late payments and high credit card debt compared to a person’s overall credit will also more negatively affect a person’s score. 

Based on the new FICO 10 model, it is estimated that 110 million consumers will not see a significant change to their score, if at all. It is also estimated that 40 million people may see an improvement to their score by more than 20 points, and 40 million others may see their score reduced by more than 20 points. 

 

What it Means for You

It is unclear when this latest FICO 10 model will be utilized because it is up to the individual lenders to determine what model they use. Some lenders are still utilizing FICO 8, which was released in 2009. Therefore, these FICO changes may not mean much for you now but could be significant in the future.  

 

These new FICO changes could help your credit score if you have a credit card balance that is occasionally high but you pay off the full balance monthly. However, if you are one of the 40 million people whose credit score is negatively impacted by this change, this may cause you to receive higher interest rates when applying for loans. If this is the case there are options:

  • Try finding a creditworthy cosigner for your loan.  
  • Try strategies to improve your score and apply after you have raised your score. 
  • Refinance if you already have a loan, but now have a higher score.

If you have student loans and the new FICO model increased your credit score, you may be eligible for a lower interest rate on your student loans through student loan refinancing, thereby potentially saving you thousands of dollars. Do your research to find the best student loan refinance companies with low-interest rates, flexible terms, no application fees, and great customer service. Also, be sure to compare the student loan refinance rates from different lenders to find the lowest student loan refinancing rates available. Student loan refinancing can be an easy process and can potentially replace your high-interest loan(s) with a lower interest rate. 

 

Want to find out if student loan refinancing is financially right for you? Check out our student loan refinance calculator to see your potential savings. At ELFI, we have no application fees, no origination fees, and no prepayment penalty. When you apply for student loan refinancing, you receive a personal loan advisor to help answer any questions and guide you through the process of refinancing.*  

 

If you have student loans and your FICO score dropped, continue to make on-time payments and try to not take on any more debt. Refinancing may still be an option since different lenders require different minimum scores. However, if you are unable to refinance now, refinancing may be a good option in the future once you have demonstrated consistent on-time payments.

 

Bottom Line 

FICO models may change, but the basic principle is the same: try to reduce any debt you have and make on-time payments. 

 

Need additional help with raising your credit score? Check out these 5 habits for good credit score hygiene.

 
 

*Subject to credit approval. Terms and conditions apply. 

 

Notice About Third Party Websites: Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – the bank is not responsible for the content. Please contact us with any concerns or comments.

young professional smiling after receiving a raise
2020-01-22
How to Use a Pay Raise Responsibly

Getting called into the boss’ office for the first time can feel a little reminiscent of getting called into the principal’s office. You immediately start sweating and wondering what you did wrong. But just like the principal's office, it's not always bad news. In fact, sometimes it's the best news of all: you just got a raise. Congrats! Take yourself out for a celebratory dinner and maybe even splurge on brunch this weekend. But come Monday morning, it's time to get down to business and determine how to use your raise.    You could just enjoy the extra cash coming into your checking account, yes. But, that little financial angel on your shoulder might also nag you about being smarter with that money. Unfortunately, most high school and college classes don’t teach us how to be responsible with our money. We learn all sorts of questionably-practical information like the Pythagorean Theorem but not how to file taxes or how to use a raise responsibly.    To cover that gap in information, we’re here with three actually practical suggestions to use that raise in a way both your principal and your boss would be proud of.   

3 Practical Tips to Use a Raise Responsibly

 

1. Boost Your Retirement Savings

If your employer has a 401(k) plan, you should already be allocating 3–5% of each paycheck toward a retirement account, especially if your employer offers a 401(k) match. This means they’ll contribute as much to your savings as you do, up to a certain amount. Many employers match contributions up to 6% of your salary, and this is, literally, free money. If you contribute 3% of your $50,000 salary, that's $1,500 a year from you and $1,500 a year from your employer for retirement savings.    When you get a raise, you should adjust your paycheck to dedicate a portion or the full amount of that raise to your 401(k) contributions. This is an easy way to save more without much thought or effort needed. If you do this right away, you don’t get used to the extra money, and you just continue living and paying bills as you did before the raise.    If you’re young, this type of contribution can be especially rewarding because of a concept called
compounding interest. This means the interest on your investment earns interest, not just the principal (or original) balance. If you invest $1,500 with a 10% interest rate, your balance would be $3,890 in 10 years. With a simple interest rate that only builds on the initial investment amount, your 10-year balance would be only $3,000.   

2. Pay Off Debts

Another savvy way to use your raise is to allocate a portion or the full amount to your debts. This can be credit card debt, student loan debt, or even repaying a personal loan from mom and dad. But debt isn’t necessarily a bad thing. Certain debts like student loans carry low interest rates so when you consider how to use your raise, consider that other accounts or investments with higher interest rates might make or save you more in the long run. For example, if your student loan has an interest rate of just 8%, it makes more sense to pay off a credit card with a 24.5% interest rate or invest in a stock with a 10% return rate.    >> Related: Should I Save or Pay Down Student Loan Debt?  

3. Allocate the Rest to An Emergency Fund

We alluded to this before, but you don’t have to put all your extra cash in one place. If you get a 5% raise, you can direct 4% toward your student loans and put even 1% in an emergency fund. You should build the emergency fund until you have at least six months of your salary in the account to help you cover bills and general living expenses in case you find yourself suddenly out of work. If six months seems unattainable, aim for at least one or two months to give you four to eight weeks to find work. This emergency fund can also come in handy if unexpected medical bills or car repairs pop up.    If you haven't been lucky enough to get a raise from your employer, or if you’re looking to boost your savings even more, you can give yourself a raise by refinancing student loans.    If you meet the eligibility requirements, student loan refinancing through companies like ELFI can get you a lower interest rate*, which means you could pay less each month and, subsequently, less over the life of the loan. Use the difference between your previous and current monthly payments as a raise. Then allocate that money to your retirement funds and toward paying off debts. ELFI customers reported saving an average of $309 every month and an average of $20,936 in total savings after refinancing student loans with Education Loan Finance.1 That’s a 7.4% raise, which is far above the predicted average 2020 cost-of-living raise of 1.6%. You can refinance both private and federal student loans.    Deciding how to use a raise responsibility is a big decision. Hopefully, with these tips, you can find ways to use those funds in a way that will give you even more play money in the future. The average raise is 4.6%, and with a little knowledge and discipline, you can turn 4.6% into thousands of dollars if you make the right choices on how to use a raise responsibly.  
  *Subject to credit approval. Terms and conditions apply.  

1Average savings calculations are based on information provided by SouthEast Bank/ Education Loan Finance customers who refinanced their student loans between 8/16/2016 and 10/25/2018. While these amounts represent reported average amounts saved, actual amounts saved will vary depending upon a number of factors.

 

Notice About Third Party Websites: Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – the bank is not responsible for the content. Please contact us with any concerns or comments.

Photo of 2020 calendar with pen
2020-01-13
Mark Your Calendar for These Important Financial Dates

It’s no secret that as you get older, life gets more complicated. Long gone are the days of simply saving spare change from your grandpa’s pockets in a ceramic piggy bank. Even that savings account you opened in high school is outdated now that your expenses have exploded beyond just food, entertainment, and a cell phone bill. As an adult, you have to consider your student loan debt, saving for retirement, and affording childcare, among an ever-growing list of other financial obligations.   One way to effectively manage your money in adulthood is to be aware of important financial dates. This helps you predict and prepare for big expenses to be sure there are no surprises. It even helps you capitalize on saving opportunities. And since it’s a new year, there’s no better time to pull out your calendar and mark these noteworthy financial deadlines.  

Important Financial Dates

 

January

  Review Last Year’s Finances – Reassess your retirement funds and allocations based on how they performed last year. If you didn’t get the gains you hoped for, now may be the time to reallocate your portfolio (i.e., adjust where your money is distributed among savings accounts, stocks, bonds, etc.) Also, take this time to consider adjusting contributions toward accounts like your 401(k) if your employee matching program changed.   Standardize Financial Dates – It’s hard enough remembering bills without them being due at different times throughout the month. Change payment dates to be on the same day at the end of the month, which gives you 30 days to get money in the right place.   Fund Your IRA – If you have a Traditional or Roth IRA (Individual Retirement Account), you can contribute up to $6,000 a year to these accounts. January 1 is the first day of the year that you can make such contributions, and investing as much as you can, as early as you can, maximizes the number of days your money can grow.   Revise Your Student Loan Debt Repayment Strategy – If you got a raise at the end of last year (or beginning of this year), be smart with that money and direct it toward your student loan debt. Even a raise of 2-3% can help you pay off loans quicker, reducing the amount of interest paid over the life of the loan.    

February

  Max Out 401(k) Contributions – Many people aren’t aware that as long as you haven’t hit your yearly limit, you can contribute toward your 401(k) beyond December 31. You have until Tax Day to make these tax-deductible contributions. So if you have the means, now is the time.
In 2019, the limit for employee 401(k) contributions was $19,000.    

March

  Prepare for Tax Day – Be ready for April 15 by getting your documents and information organized in advance. Make sure you have all forms needed from your employer, investment accounts, mortgage accounts, and student loans. TurboTax has a handy guide for commonly-used IRS tax forms, including a Form 1098 that you’ll receive if you paid interest on a student loan last year.    

April

  File Your Taxes – April 15 is Tax Day in the U.S. For those of us with student loan debt, the interest portion of these payments is tax-deductible, up to $2,500.   Maximize Health Savings Accounts – Tax Day is the last day to contribute pre-tax dollars to last year’s HSA. In 2019, individuals could contribute up to $3,500 as an individual or $7,100 as a family.   Spend Down Flexible Spending Accounts – April 30 is the deadline for spending last year’s FSA funds. Remember, these are “use it or lose it” accounts and money can be applied to copays or other out-of-pocket expenses. You can even spend it on health-related items at FSAstore.com.    

May

  Check Your Credit – This important financial date isn’t tied to May, but it should be somewhere on your calendar every year. Your score determines your ability to improve your interest rate with student loan refinancing. A check can also let you know if any fraudulent activity—tied to your name—has occurred that might negatively impact your student loan refinancing.    

June

  FAFSA Application Due – June 30 is the last day to complete the Free Application for Federal Student Aid (FAFSA) for the upcoming school year. If you already have a student loan, consider student loan refinancing. By consolidating and refinancing your loans, you can make payments simpler and possibly reduce your monthly payments.    

July

  Refinance Student Loans – Summer is a great time to refinance student loans because you won’t be distracted by the holidays or year-end deadlines at work. When you’re ready, check your eligibility for student loan refinancing at ELFI.com.*    

August

  Contribute to Emergency Funds and Savings – Unless someone in your family heads back to school this fall, August is typically a sleepy month for finances. Time to double-check that you’re contributing to emergency funds and holiday savings accounts so you don’t get into financial trouble during end-of-the-year festivities.    

September

  Car Shop – This month is a great time to look for a new vehicle. Dealerships are in a generous mood since new models will soon start rolling into the lot, and they need to clear inventory.    

October

  Complete FAFSA for Next Year – October 1 is the first day to file your FAFSA for next school year. Filling out this application as soon as possible ensures you don’t miss out on available aid.    

November

  Open Enrollment – Employers typically hold open enrollment during this time of year. Reassess if your current plan still works for you. Also consider if it’s worth changing plans or opting out of certain coverage (like dental) to reallocate funds to debts, like student loans.    

December

  Review Accounts – Make sure you’re making the right moves to use your FSA money, maximize contributions to savings accounts, and even if you need to file a new W-4 to withhold more or less money from your paychecks. Withholding less can be part of a new student loan repayment strategy where you have more cash to contribute toward the loan. However, it also means you won’t get as big of a refund next tax season.   Shop Around for Car Insurance – While you’ll want to update your car insurance after any major life change, such as moving or having a child, you could score additional savings depending on the time of year. In a 2014 study, December was the cheapest month to obtain car insurance, with March being the most expensive. While the jury’s still out on the exact reasoning behind the shift, market competition and the likelihood of natural disasters could be a contributing factor.   Being aware of important financial dates can help you save and manage your money so you have more options down the road for student loan repayment, business opportunities, and real estate investments.   If you’re ready to explore student loan refinancing, you don’t have to wait for an important financial date on the calendar. You can learn about eligibility, benefits, and more—today—at ELFI.com.   This blog has been prepared for informational purposes only and does not constitute financial advice. Always consult a professional for guidance around your personal financial situation.             *Subject to credit approval. Terms and conditions apply.   Notice About Third Party Websites: Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – the bank is not responsible for the content. Please contact us with any concerns or comments.