Tuesday, October 28, 2014

Student debt, interest rates, and mortgage qualification -- post two



A previous post showed how to calculate the impact of student debt on mortgage qualification outcomes.  



This post examines the impact of changes in the student loan interest rate and changes in the amount of student debt on the amount of income needed to qualify for a mortgage.


Question:  We have a borrower with a lot of student debt trying to buy a $300,000 house.   In the basic scenario in the left column the student has a $100,000 student loan at 7.0%.   Three other scenarios are considered  -- student debt $110,000 and interest rate 7.0%, student debt $100,000 and interest rate 7.5%, and student debt $110,000 and interest rate 7.5%.

I have bolded and placed in red the student debt and interest rate assumptions that are central to this post.


How do these changes in student debt totals and interest rates impact the ability of the student borrower to qualify for this mortgage.?

What is more likely to impede the real estate transaction  -- an increase in student debt from $100,000 to $110,000 or an increase in the interest rate on student loans from 7.0% to 7.5%.

Answer:   I expand the spreadsheet from the previous post to four columns and presented answers for four scenarios.

Mortgage Qualification Example for Borrower with Student Debt
Student loan Amount
$100,000
$110,000
$100,000
$110,000
Interest Rate
0.07
0.07
0.075
0.075
Number of Payments
180
180
180
180
Student Loan Payment
$898.83
$988.71
$927.01
$1,019.71
House Amount
$300,000
$300,000
$300,000
$300,000
LTV
0.9
0.9
0.9
0.9
Loan Amount
$270,000
$270,000
$270,000
$270,000
Interest Rate
0.045
0.045
0.045
0.045
Number of Payments
360
360
360
360
Mortgage Payment
$1,368.05
$1,368.05
$1,368.05
$1,368.05
Sum of Mortgage Payment and Non Mortgage Debt Payment
$2,266.88
$2,356.76
$2,295.06
$2,387.76
Monthly Income needed to cover mortgage interest
$4,885.89
$4,885.89
$4,885.89
$4,885.89
Monthly Income Needed to cover all Debt Payments
$5,965.47
$6,202.00
$6,039.64
$6,283.59
Amount of Income Needed
$5,965.47
$6,202.00
$6,039.64
$6,283.59


The impact of the 10% increase in student debt is worse than the 0.5 percent point increase in interest rate.


I just noticed that the chart above assumes a student loan with a 15-year term.   This is not wrong because many student borrowers are forced to extend their loan but the standard loan used to be for 10 years.  Let's look at the chart when the term is ten years.


Mortgage Qualification Example for Borrower with Student Debt With a 10-year term
Student loan Amount
$100,000
$110,000
$100,000
$110,000
Interest Rate
0.07
0.07
0.075
0.075
Number of Payments
120
120
120
120
Student Loan Payment
$1,161.08
$1,277.19
$1,187.02
$1,305.72
House Amount
$300,000
$300,000
$300,000
$300,000
LTV
0.9
0.9
0.9
0.9
Loan Amount
$270,000
$270,000
$270,000
$270,000
Intrerest Rate
0.045
0.045
0.045
0.045
Number of Payments
360
360
360
360
Mortgage Payment
$1,368.05
$1,368.05
$1,368.05
$1,368.05
Sum of Mortgage Payment and Non Mortgage Debt Payment
$2,529.14
$2,645.24
$2,555.07
$2,673.77
Monthly Income needed to cover mortgage interest
$4,885.89
$4,885.89
$4,885.89
$4,885.89
Monthly Income Needed to cover all Debt Payments
$6,655.62
$6,961.17
$6,723.86
$7,036.24
Amount of Income Needed
$6,655.62
$6,961.17
$6,723.86
$7,036.24



So in some ways the debate between what is worse more debt or higher rates is a bit like the miller light debate great taste or less filling.
At ten years the 100,000 student loan really increases the amount that the household has to borrow to get a mortgage.   Again, an increase in student debt of $10,000 has a larger impact than a half percent increase in rates.  But pessimists about interest rates should not worry.   Some day there will be huge interest rate shock which be worse to the world than the increased debt.  A lot of student borrowers  will be totally screwed but the pessimists concerned about interest rates can be happy because they will have been proven correct.  

Concluding Thought:   The government actually makes a profit on student loans.   This troubles me a lot.

Still, my sense of the numbers suggests the main concern involves increases in debt totals not interest rates.

This could change in the future if interest rates rise.

This student borrower has a lot of student debt.  But even a modest amount of student debt can impede mortgage qualification if the borrower has an auto loan and some credit card debt.  I will work up an example to show this.





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