The Definition Of The Eight Percent Rule For Student Loans

The maximum amount that any student can borrow is adjusted from time to time as federal policies change. A study published in the winter 1996 edition of the Journal Of Student Financial Aid, “How Much Student Loan Debt Is Too Much?” explains this concept.

It suggests that the monthly student debt payment for the average undergraduate should not exceed 8 percent of total monthly income after graduation. Some financial aid advisers have referred to this as “the 8 Percent Rule.”

Circumstances vary for individuals, so the 8 percent level is an indicator, not a rule set in stone.

A Financial Path To Graduation

The 8 percent program was developed at Brigham Young University nearly ten years ago where it takes a need-based approach to asking questions to determine, where will my current course of action take me? Will I be able to afford this situation?

This process requires a student to evaluate their individual path to determine if it will lead them to a firm footing at graduation, as opposed to the all-too-common scenario of owing more than can be afforded.

How the Eight Percent Rule Works

The program has a budget worksheet to help you plan your future income and expenses after you graduate. It actually has several calculators in one. It can determine:

1. How much interest would be capitalized on unsubsidized Stafford loans (if you do not pay the interest while you are in school or during your grace period.)
2. How much your monthly payment amounts would be after adding in capitalized interest.
3. What percent of your income is taken up in student loan payments, based upon you career choice.

Your results are presented on a graph, which represents the percent of student loans to projected earnings over time. As our income increases, student loans represent a lower percentage. When the loan is paid off, the percent is zero.

You choose the information to be placed on the graph to determine the end result. The results prove to be very helpful. Following are your choices:

You choose your career from over 20 occupational categories in a dropdown box. Entry-level salaries are displayed with each career.

You enter each loan you plan to borrow by academic year and grade level. This will take a little planning, but the chart has loan limits to assist you. You also need to estimate the dates you plan to begin college and graduate.

You may change the interest rate, loan term (years for repayment) and minimum monthly payments that are already entered.

You can see how much you can save on interest if you shorten the loan term or raise the minimum payments. You can also see how much lower you payments will be if you choose to pay interest on an unsubsidized Stafford loan while you are in school and during your grace period.

Obviously this is a guideline only. Yet it allows a student at any stage of their education to take stock on where they are. And it is a very nice tool to be able to program other financial responsibilities (car payment, credit cards, etc.) into the picture to examine your current student loan borrowing status.

DTI: Debt-to-Income Ratio

The dictionary meaning is: the ratio of a borrower’s total of debt as a percentage of their total gross income. In this particular article we will be using this term and referring to it as an example relating to mortgages. However, it can be used for almost any loan.

Your debt-to-income ratio is a simple way of showing what percentage of your income is available for a mortgage payment after all other continuing obligations are met; or, the relationship between what you owe and what you make.

Debt is a problem that plagues many of us today. If unmonitored, your debt can grow at an alarming rate and the next thing you know your finances are in shambles. If you want to identify your overall financial situation and keep your debt in check, you need to establish your debt-to-income ratio.

How To Calculate Your Ratio

You will usually see conventional loan debt limits referred to as the 28/36 qualifying ratio (or other numbers up to 36/42 depending on the type of loan). These numbers refer to two percentages that are used to examine two areas of your debt load.

The first number indicates the maximum percentage of your monthly gross income that the lender will allow for housing expenses. This includes loan principal, interest, private mortgage insurance, hazard insurance and property taxes.

The second number refers to the maximum percentage of your monthly gross income the lender allows for your housing, credit cards, car loans and other obligations that will not be paid off within a short period of time (6-10 months).

Items such as monthly food bills, utility bills and entertainment expenses should not be considered when calculating your debt-to-income ratio. These expenses can be paid off monthly.

To calculate your ratio, take your monthly debt payment and divide it by your monthly take home income. The end result is your debt-to-income ratio. Let’s look at an easy example:

Monthly income: $4,000

Monthly debt payment: $1,850

Debt-to-income ratio: $1,850 / $4,000 = 46%

If you have a ratio of 10 percent or less, it means you have a GREAT debt-to-income ratio, meaning your income is quite a bit more than what you owe. However, if you have a debt-to-income ratio of 55 percent or higher, it means you have too much debt and are considered a risk for a mortgage loan.

Debt-to-Income Ratio and Lenders

Lenders calculate and analyze your ratio to determine the size of mortgage you can afford. In fact, these numbers are frequently the most important numbers that lenders look at when quoting you a mortgage amount and interest rate.

These numbers not only determine if you qualify for a mortgage loan, but the monthly payment you will be paying and for how many years. These numbers tell the lender a lot about a person and how they handle their money.

So in the end, the best thing to do is to keep your debt under control and not to take on too much. It could hinder your ability to qualify for your dream home and if not, it would send your finances plummeting.