We’ve all heard the stories about the crushing levels of student loan debt among recent – and not so recent – college grads. Americans now owe more than $1 trillion in education-related debt, with an average loan balance of roughly $30,000 (Source: U.S. News & World Report, November 13, 2014).
All that debt is making it difficult for young people to become financially independent and move forward toward major financial milestones. In fact, many experts are concerned that high levels of student loan debt are actually causing people to delay home ownership (Source: The Federal Reserve, 2014). Studies by the Federal Reserve seem to suggest that people with student loans are more likely to put off buying a home until their 30s.
Yet other experts say that while high levels of student loan debt may be one factor in causing young people to delay home ownership, it’s not the only one. A tough job market and low wages are big problems as well. So is the fact that young people are delaying key milestones like getting married and having children, which tend to be associated with home ownership. Even those with high levels of debt may not be shut out of home ownership. While big monthly payments and steep debt totals can be an obstacle to buying a house, that’s not always the case, especially when big student loan totals are associated with advanced education that leads to higher earnings (like law school or medical school).
Whether or not high levels of student debt are affecting the broader housing market, it’s likely having at least some impact on individual borrowers and homebuyers. People with high monthly student loan payments may struggle to save up enough for a down payment, especially if their income is relatively low. Also, if they have a mountain of student loans to pay back, they may be hesitant to add a mortgage on top of that, even if they can technically afford it.
People who are overwhelmed by their educational debt – a small but significant share of total borrowers – are in an even worse spot. Student loans are virtually impossible to discharge in bankruptcy. That debt will follow you around for life, even if you’re unable to pay. And defaulting on your student loans will wreak havoc on your credit score, making it extremely difficult to buy a house, especially in an environment where lending standards are far higher than they were a decade or so ago. Even if you’re diligent about paying that bill every month, mortgage lenders may still think your debt levels are too high relative to your income and deny your application.
In fact, their debt-to-income ratio is one key number that prospective homebuyers need to understand before they even start looking through real estate listings. It’s a number that’s determined by dividing your total monthly liabilities (including student loans, credit card payment, auto loans, and your anticipated mortgage amount) by your totally monthly income. Lenders generally want to see a debt-to-income ratio of 43% or less. More than that, and your loan application is likely to be denied.
Say you earn $4,000 a month, and you have a $300 monthly student loan payment, a $150 monthly car payment, and a $75 monthly payment on your credit card. To buy the home you want, you’ll need a mortgage of $250,000, which translates to a monthly payment of about $1,500. Your total monthly debt payments including the mortgage will by $2,025. Divide that by your $4,000 in monthly income and you have a debt-to-income ratio of 51%. That’s higher than many mortgage lender want to see, and you may be denied when you apply for a loan.
But what if you didn’t have that student loan payment? Subtract the $300 from your liability and your monthly payments fall to $1,725. That gives you a debt-to-income ratio of 43%, low enough to increase your chances of qualifying for a mortgage.
Of course, financial matters are rarely as simple as in the example outlined above, and a $300 monthly student loan obligation doesn’t mean that you won’t be able to buy a house. The person above could try to eliminate his/her other debts, save for a larger down payment, earn more money, or look for a cheaper house. But the fact remains: How much you owe today is going to affect how much you are going to be able to borrow in the future.
Copyright © Integrated Concepts 2015. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.