The consequences of student loan debt for the average person have led to the deferral of purchases and major expenses such as cars, houses, and marriage. Most college graduates understand that combining their early payments on their education loans with additional debt will be a severe barrier to achieving their dreams. In 2012, student loan debt is estimated to have exceeded $ 1 trillion (CollegeBoard.org). Average student loan debt per person is nearly $ 30,000 (Federal Reserve Bank of New York, 2013).
One of the key factors in qualifying for a mortgage is the debt-to-income ratio that lenders use. Lenders use a debt-to-income ratio to calculate the mortgage payment and the borrower’s income; This is called a frontal relationship. For most lenders, an initial ratio can be as high as 31% of the borrower’s income. Lenders also calculate the total debt and income of the borrowers. This debt-to-income ratio is called the back-end debt ratio. Typically, the debt-to-income ratio can be as high as 43% of the borrower’s income. Below is an example of the impact of the impact of the average person’s student loan debt on a mortgage qualification. For these examples, we will assume a credit card debt of $ 150 per month and an installment loan (car loan) of $ 350 per month. The income used is $ 48,000 per year (or $ 4,000 per month).
Front-end relationship
Under this guideline, 31% of the borrower’s monthly income ($ 4,000) can be used to cover his mortgage obligations. This would be equivalent to a purchasing power of $ 1,240. Assuming that the guarantee deposits (taxes, insurance and pmi) are equal to $ 500 per month; the buyer could obtain a 30-year mortgage of $ 146,000.
However, the borrower must also adhere to the initial and final ratio guidelines. Below is an example of two different buyers, one with an average student loan debt of $ 30,000 with the standard 10-year repayment option, and one with no student loans.
Back-end debt ratio
Under this guideline, 43% of the borrower’s monthly income ($ 4,000) can be used for all of his debts (mortgages, cars, credit cards, and student loans).
Example 1: (Buyer without student loans)
$ 4000 (monthly income) x 43% = $ 1720 (total monthly allowable debt)
Debts
Auto $ 350 + credit cards $ 150 = $ 500 debt (excluding mortgage obligation)
$ 1,720 (total monthly debt allowed) – $ 500 (debt) = $ 1,220 or $ 142,000 in available mortgage power *
Example 2: (buyer with average student loan debt of $ 30,000)
Debts
Car $ 350 + credit cards $ 150 + student loan $ 342 (based on 10-year amortization @ 6.65%) = $ 842 debt (excluding mortgage obligation)
$ 1,720 (total monthly debt allowed) – $ 842 (debt) = $ 878 or $ 74,000 in available mortgage power *
• In the examples above, a 30-year fixed rate of 4.50% was used.
In the above examples, the only difference is the average student loan debt as reported by the Federal Reserve Bank of New York. The average student loan borrower has enormous mortgage power of $ 68,000 less.
One solution for prospective home buyers with student loans is income-based repayment plans. Income-based payment plans offer the lowest monthly payment options. The maximum monthly payments are 15% of discretionary income, which is the difference between adjusted gross income and 150% of the poverty guideline based on family size and location. Payments can change every two years as income changes. Payments can continue for up to 25 years. This information would give recent college graduates the ability to modify their financial obligations in a way that enables them to qualify for a mortgage. The US Department of Education offers multiple educational loan repayment plans based on the borrower’s income. Even if a payment plan has already been selected, the payment plan can be changed at any time. According to the Federal Student Loan Aid website, Income Contingent Payment Plan payments are calculated based on adjusted gross income, family size, and total amount of Direct Loan Program loans. The income-sensitive payment plan calculates monthly payments based on annual income. Generally, the minimum monthly payment option is $ 50 unless a zero monthly payment is calculated based on the income base payment plan. Any amount not paid after 25 years of making qualified monthly payments can be forgiven, but any amount forgiven may be taxable.
References:
http://www.newyorkfed.org/studentloandebt/
Federal Student Aid https://studentaid.ed.gov/repay-loans/
Mishory, J. and O’Sullivan, R. (2012). Denied? The impact of student debt on the ability to buy a home. Invincible youth.
Trends.collegeboard.org