The consequences of student loan debt for the average person have caused the postponement of major purchases and expenses such as automobiles, houses, and marriage. Most college graduates understand coupling their anticipated education loan payments with additional debt will pose a severe barrier in achieving their dreams. It is estimated that in 2012, student loan debt exceeded one trillion dollars (CollegeBoard.org). The 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 used by lenders. Lenders use a debt to income ratio calculating the mortgage payment and the borrower’s income; this is called the front end ratio. For most lenders a front end ratio can be as much as 31% of a borrower’s income. Lenders also calculate total debt and the borrowers’ income. This debt to income ratio is called the back end debt ratio. The debt to income ratio can typically go up to 43% of the borrower’s income. Below is an example of the impact of the average person’s education loan debt impact on qualifying for a mortgage. For these examples we will assume credit card debt of $150 per month and an installment loan (auto loan) of $350 monthly. The income used is $48,000 annually (or $4000 monthly).
Front End Ratio
Under this guideline 31% of the borrower’s monthly income ($4000) can be used towards their mortgage obligation. This would equal purchasing power of $1240. Assuming escrows (taxes, insurance, and pmi) equal $500 monthly; the buyer would be able to obtain a 30 year mortgage of $146,000.
However, the borrower must also meet the guidelines of both the front and back end ratios. Below is an example of two different buyers, one with average student loan debt of $30,000 with the standard 10 year pay back option and one without student loans.
Back End Debt Ratio
Under this guideline 43% of the borrower’s monthly income ($4000) can be used towards all their debts (mortgage, auto, credit card debt, and student loans).
Example 1: (Buyer without student loans)
$4000 (monthly income) x 43% = $1720 (total allowed debt monthly)
Auto $350 + credit cards $150 = $500 debts (excluding mortgage obligation)
$1720 (total allowed monthly debt) – $500 (debts) = $1220 or $142,000 in available mortgaging power *
Example 2: (buyer with average student loan debt of $30,000)
Auto $350 + credit cards $150 + student loan $342 (based on 10 year payback @ 6.65%) = $842 debts (excluding mortgage obligation)
$1720 (total allowed monthly debt) – $842 (debts) = $878 or $74,000 in available mortgaging power *
• 4.50% 30 year fixed rate was used in the above examples
In the above examples, the only difference is the average student loan debt as reported by The Federal Reserve Bank of New York. The borrower with the average student loan debt has a whopping $68,000 less in mortgaging power.
One solution is for potential homebuyers who have student loans, are the Income Based Repayment plans. The Income Based Repayment plans offer the lowest monthly payment options. The maximum monthly payments are 15% of discretionary income, which is the difference between the adjusted gross income and 150% of the poverty guideline based on family size and location. Payments may change as often as every two years as income changes. Payments may continue for up to twenty-five years. This information would empower recent college graduates with the ability to alter their financial obligations in a manner which allows them to qualify for a mortgage. The U.S. Department of Education offers multiple repayment plans for educational loans based on the borrower’s income. Even if a repayment plan has already been selected, the repayment plan can be changed at any time. According to the Federal Student Loan Aid website, Income Contingent Repayment plan payments are calculated based on adjusted gross income, family size, and the total amount of Direct Loans. The Income Sensitive Repayment plan calculates monthly payments based on annual income. Typically the minimum monthly payment option is $50 unless a zero monthly payment is calculated under the Income Base Repayment plan. Any unpaid amount after 25 years of making qualified monthly payments may be forgiven, but any forgiven amount may be taxable.
Federal Student Aid https://studentaid.ed.gov/repay-loans/
Mishory, J., & O’Sullivan, R. (2012). Denied? The impact of student debt on the ability to buy a house. Young Invincibles.