If you’ve been dreaming about buying a home, you’ve almost certainly been taking a close look at your finances. If your student debt is an obstacle to your home purchase, you aren’t alone by a long shot. The numbers show that about 61% of Millennials still don’t own a home and a 2019 Bankrate survey shows 25% blame the cause on student debt.
Student debt can hold you back from owning a home in two important ways. First, a large monthly student debt payment can be an obstacle to saving for the down payment. Even if you do manage to save the down payment, that same student debt payment is likely raising your debt-to-income ratio to a level that prevents you from qualifying for a mortgage. With interest rates at historic lows, now is the time to take action to refinance that student debt and take advantage of the same low-interest rate to qualify for a mortgage.
You cannot simply refinance your student debt one week and then qualify for a mortgage the next week. Doing both can be done but it takes both planning and a little time. The place to begin is by deciding on a strategy.
First, you need to decide if it makes good sense to refinance your student debt. This is an important consideration if you have a government-backed student loan that you are considering converting to a private loan. The timing might not be right if you have a government loan on an income-driven repayment plan and you need a lower payment because your income has dropped. Another consideration is if the government loan might offer some type of loan forgiveness or forbearance. Still, another consideration is if the loan is close to being paid off and refinancing won’t bring any significant savings or a lower monthly payment. If you’re having trouble figuring this out on your own, you might want to seek out the help of a financial planner.
Your refinancing option requires deciding between refinancing the student debt before or after applying for a mortgage - or refinancing the student debt twice. Generally, you’ll want to refinance the student debt first to lower your debt to income ratio. This is going to take at least several months after you begin the student debt refinancing process. There is the red-tape time-lag to apply for, be approved for, and complete the student debt refinancing. But it also takes time for the refinancing to work its way through your credit report. There is a good chance that both the old student loan and the refinanced loan will both appear on your credit report for a month or two until the old loan is recorded as being paid off. And then you’ll need a few more months to establish a record of making on-time payments for the new loan.
And there is the option of refinancing the student debt twice. This strategy involves first refinancing the student debt for a longer period of time. Let’s say increasing the loan term from 10 years to 20 years. The point is that your monthly payment will be reduced and that will lower your debt to income ratio. But longer-term loans usually don’t qualify for the lowest interest rate and you probably don’t want to be paying on that loan for an extra 10 years. The solution can be refinancing the student debt again after you qualify for a mortgage. This lets you buy your home, lower the interest rate on the student loan, and refinance the final student loan for a shorter period of time. Again, you might want to seek out the help of a financial planner.
You keep hearing about your debt to income level, which means you need to understand what it is, how to calculate it, and how to improve it. Your debt-to-income ratio (DTI) is one of the most important factors a lender looks at when evaluating your application. Lenders want to ensure you have the cash flow (monthly income) to handle your new mortgage payment, while also staying current on all your existing debts (student loans included).
The numbers vary depending on the lender and loan type but generally most mortgages you can’t have a DTI higher than 28% before including the new mortgage. After subtracting out your current rent and estimating your new mortgage with related expenses (insurance and taxes), 36% is the maximum DTI.
Your DTI is calculated by dividing your monthly debt payments by your monthly gross income. The ratio is expressed as a percentage. To calculate your DTI, add up all of your monthly debts – rent, student loans, personal loans, auto loans, minimum credit card payments, child support, etc. Next, divide the sum by your monthly gross income. Some expenses are not part of this calculation - utilities, groceries, insurance premiums, healthcare costs, daycare, etc.
For example, if your monthly debt equals $2,500 and your gross monthly income is $7,000, your DTI ratio is slightly less than 36%. (2,500/7,000 = 0.357). There are online calculators to help you with this but you’ll have to do the work to determine all of your debts and income. An online calculator can be handy for checking different sets of numbers based on the strategies discussed above.
Refinancing your student loan and buying a home are both major financial decisions. These decisions often affect each other. Before jumping into either process, it’s important to consider how they work together.
Please comment with your thoughts about refinancing student loans to qualify for a mortgage.
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