Wednesday, October 29, 2014

Student loans, consumer debt and mortgage qualification – post three

Student loans, consumer debt and mortgage qualification – post three

Background: Previous posts looked at mortgage qualification outcomes for a person with a lot of student debt but no other consumer debt.


Creates and explains a model of mortgage qualification for borrowers with student debt:


Estimates the sensitivity of mortgage qualification to changes in student debt totals and student loan interest rates:


This post considers a household with more modest student loans but additional consumer debt.

We show that for  a household with a $50,000 student loan and no consumer debt the student loan will probably not impede mortgage qualification outcomes.  However, add a modest amount of other consumer loans and the student borrower with $50,000 in student debt will probably be renting for a few years. 

Question:   Consider two households trying to qualify for a $270,000, 4.5 percent, 30-year FRM mortgage.   Both households have a $50,000 student loans with a 7 percent interest rate. 

Caution:   this particular post assumes a 15-year student debt.   This assumption is not wrong because I believe many student loan programs allow for the student to extend the term of their loan to as long as 20 years.   Still I believe most students should aim at 10 years.  Let me know what you think on this point and whether I should redo the post for 10 years.  


  One household has a $250 auto loan and a $120 minimum monthly payment on credit cards.   The other household has zero additional consumer debt.

How much income do the two households need to qualify for a mortgage? 

What is the impact of the student debt on the qualification outcome?

Answer:    The situations for the two households are outlined in the table below.
  

Student Debt, Consumer Debt, and Mortgage Qualification
Student borrower with other consumer loans
Student borrower with no other consumer loans
Student loan Amount
$50,000
$50,000
Interest Rate
0.07
0.07
Number of Payments
180
180
Student Loan Payment
$449.41
$449.41
Car Payment
$250.00
NA
Minimum Credit Card Payment
$120.00
NA
House Amount
$300,000
$300,000
LTV
0.9
0.9
Loan Amount
$270,000
$270,000
Interest Rate
0.045
0.045
Number of Payments
360
360
Mortgage Payment
$1,368.05
$1,368.05
Sum of Mortgage Payment and Non Mortgage Debt Payment
$2,187.46
$1,817.46
Monthly Income needed to cover mortgage interest
$4,885.89
$4,885.89
Monthly Income Needed to cover all Debt Payments
$5,756.49
$4,782.80
Amount of Monthly Income Needed to Qualify for a Mortgage
$5,756.49
$4,885.89


Below I summarize the results in terms of annual income needed from the mortgage debt to income constraint, the total debt to income constraint, and the binding constraint.  (Recall the binding constraint is the one where required income is the maximum.)



Annual Income needed to qualify two borrowers
Student borrower with other consumer loans
Student borrower with no other consumer loans
Annual Income from mortgage
 debt constraint
$4,885.89
$4,885.89
Annual Income from total
 debt Constraint
$5,756.49
$4,782.80
Amount Income Needed  -- 
Max of the two limits
$5,756.49
$4,885.89


Observations:  

The binding constraint for the student borrower with the extra consumer loans is the required ratio of total debt to income.

The binding constraint for the student borrower with $0 extra consumer debt is the mortgage debt to income ratio.


Extra Credit:   For extra credit, the reader should calculate the house value that would result in a binding total debt to consumer loans constraint for the student borrower with no additional consumer loans.   Recall, student loans play a larger role on less expensive houses because the mortgage debt constraint is the binding one on expensive homes. 

Concluding thought:  Even when student loans are “only” $50,000 there could be a substantial impact on mortgage qualification when household has modest levels of other consumer loans.  


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