Saturday, November 1, 2014

How much house can a person with student debt qualify for?

How much house can a student borrower qualify for?

Previous posts asked how much income would be needed for a person to qualify for a particular mortgage.



This post asks how much house a person with a particular income buy.  I assume he has a large student loan, which can be set to a 10-year or 20-year term.

Situation:

Consider a person with a $100,000 student debt.   The person can either pay the debt back over a 10-year period or a 20-year period.

The student loan is this person’s only consumer debt.

The person earns $80,000 per year.

The student loan interest rate is 7.0 percent.

The mortgage interest rate is 4.0 percent. 

 The mortgage term is 30 years.

Questions:

How much mortgage can the person qualify for if the person keeps the student loan at 10 years?

How much mortgage can the person qualify for if the person changes the student loan term to 20 years?

What is the increased cost of the student loan payments involved by switching from a 10-year to 20-year student loan?


Answer:   I developed a spreadsheet that calculates the maximum allowable mortgage this person can qualify for.


In order to qualify for a mortgage two conditions must hold.

Monthly mortgage payments must be less than 28% of income.

Monthly mortgage and consumer loan payments must be less than 38% of income.


First, I calculate the maximum allowable mortgage payment based on zero consumer debt.   This value is 28 percent of monthly income. 

Second, I calculate the maximum allowable mortgage payment consistent with mortgage payments and consumer debt payments equal to 38 percent of income.   This is done by backing out the consumer loans and allocating the rest to mortgage debt.

I insert mortgage interest rate, term and payment info into the PV functions to get the mortgage amount

The allowable mortgage is the minimum of the mortgage totals consistent with the two constraints.

The calculations for the two situations presented in this problem are presented in the table below



Mortgage Qualification Example for Borrower with Student Debt
row #
Student Loan Information
Note
1
Student loan Amount
$100,000
$100,000
Assumption
2
Interest Rate
0.07
0.07
Assumption
3
Number of Payments
120
240
Assumption
4
Student Loan Payment
$1,161
$775
From  PMT Function
Mortgage Information
5
Rate
0.035
0.035
6
Term
360
360
Income Assumption
7
Income
$80,000
$80,000
Assumption
8
Constraint One:  Maximum monthly mortgage payment consistent with this income assumption
$1,867
$1,867
28% of monthly income
9
Constraint Two:  Maximum monthly consumer and mortgage payments consistent with income
$2,533
$2,533
38% of monthly income
10
Maximum mortgage consistent with constraint one.
$415,697
$415,697
pv of mortgage rate number of periods, and pmt where mortgage rate and payments are assumptions baed on the market and product chosen and payment is max allowable given income
11
Allowable mortgage payment consistent with constraint two given required student debt
$1,372
$1,758
Row 9 minus Row 7
12
Max mortgage consistent with borrowing contraint two.
$305,593
$391,505
Use PV function with rate and term set by market and product and payment the amount of mortgage payment after required consumer payments
13
Allowable mortgage debt
$305,593
$391,505
Minimum of Row 10 and Row 12



An increase in the term of the student loan from 10 to 20 years increases the size of a mortgage a household can qualify for from $305,000 to $391,000.


Getting the extra mortgage is not cheap.  The increased student loan term causes total student loan payments to go from $139.000 to $186,000.

Concluding thoughts:  Most people who have $100,000 in student debt will have to refinance the student loan if they are going to buy a house. 

Another strategy that needs to be considered is delay for five years pay off as much of the student loan as you can and then buy.

The problem is even more complex for people with other consumer loans like credit cards and a smaller amount of student debt.   In this case, refinancing the student loan does not increase the amount of mortgage a person can qualify for by that much.

A discussion of mortgage qualification when a borrower has less student debt but additional consumer loans can be found at the post below.




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