Tuesday, October 28, 2014

Student debt and qualifying for a mortgage -- post one

Student debt and qualifying for a mortgage  -- post one

Excel Topics:  PMT function and Spreadsheet design

Question:  A person graduates from college and graduate school with $100,000 in student debt.   The interest rate on a 10-year student loan is 5% per year.   The person wants to buy a house that costs $300,000 with a 90% LTV loan. The home mortgage interest rate is 4.5% on a 30 year FRM.

Assume that in order to qualify for the house the person must meet two conditions.  

Constraint One:  The ratio of mortgage interest to income must be less than 0.28. 

Constraint Two: The ratio of total interest (mortgage and non-mortgage) interest must be less than 0.38.

How much income does this person need to qualify for a loan on this house? 

Why might student debt have a smaller impact on the purchase of a $700,000 home than the purchase of a $300,000 home.


Analysis:   The analysis for the $300,000 home is laid out in the table below.



Mortgage Qualification Example for Borrower with Student Debt
Note
Student loan Amount
$100,000
$0
Assumption
Interest Rate
0.05
0.05
Assumption
Number of Payments
120
120
Assumption
Student Loan Payment
$1,061
$0
From  PMT Function
House Amount
$300,000
$300,000
Assumption
LTV
0.9
0.9
Assumption
Loan Amount
$270,000
$270,000
LTV * House Amount
Intrerest Rate
0.045
0.045
Assumption
Number of Payments
360
360
Assumption
Mortgage Payment
$1,368
$1,368
From PMT Function
Total Loan Payments
$2,429
$1,368
Sum Payments
Monthly Income Constraint One
$4,886
$4,886
Student Loan Payment divided by 0.28
Monthly Income Constraint Two
$6,391
$3,600
Mortgate Payment Divided by 0.38
Required Monthly Income
$6,391
$4,886
Max of income over both constraints
Required Annual Income
$76,696
$58,631
12* Max Income

Observations Pertaining to the $300,000 home for a person with and without student loans

A person with no student debt could qualify for this mortgage with an annual income of $58,630.

The person with the student debt needs an annual income of $71,585.

The impact of student debt on purchases of a larger home:   The allowable mortgage is determined by two constraints one involving mortgage debt only and the other involving the sum of mortgage and consumer debt.   When the mortgage debt is very large, constraint one (the mortgage debt constraint) will be the binding constraint.

Authors Notes:  Go to the Excel Finance Function Tutorial  question nine for follow up questions involving modifications of this spreadsheet.


Actual mortgage calculators, which include informations on taxes and insurance are more complicated than the one I am presenting.  Links to these calculator are presented below.    


A qualification calculator for FHA loans:


A calculator from BankRate:

























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