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Buying a House When You Have Student Loan Debt

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Buying a House When You Have Student Loan Debt

Student loan debt is a reality for many people wishing to buy homes. Fortunately, it does not have to be a deal-breaker. But there’s no getting around the fact that a large amount of student loan debt will certainly influence how much financing a lender will be willing to offer you.

In the past, mortgage lenders were able to give people with student loans a bit of a break by disregarding the monthly payment from a student loan if that loan was to be deferred for at least one year after closing on the home purchase. But that all changed in 2015 when the Federal Housing Authority, Fannie Mae, and Freddie Mac began requiring lenders to factor student debt payments into the equation, regardless of whether the loans were in forbearance or deferment. Today by law, mortgage lenders across the country must consider a prospective homebuyer’s student loan obligations when calculating their ability to repay their mortgage.

The reason for the regulation change is simple: with a $1.3 million student loan crisis on our hands, there is concern homebuyers with student loans will have trouble making either their mortgage payments, student loan payments, or both once the student loans become due.

So, how are student loans factored into a homebuyer’s mortgage application?

Anytime you apply for a mortgage loan, the lender must calculate your all-important debt-to-income ratio. This is the ratio of your total monthly debt payments versus your total monthly income.

In most cases, mortgage lenders now must include 1% of your total student loan balance reflected on the applicant’s credit report as part of your monthly debt obligation.

Here is an example:

Let’s say you have outstanding student loans totaling $40,000.

The lender will take 1% of that total to calculate your estimated monthly student loan payment. In this case, that number would be $400.

That $400 loan payment has to be included as part of the mortgage applicant’s monthly debt expenses, even if the loan is deferred or in forbearance.

Are Student Loans a Mortgage Deal Breaker? Not Always.

If you are applying for a “conventional” mortgage, you must meet the lending standards published by Fannie Mae or Freddie Mac. What Fannie and Freddie say goes because these are the two government-backed companies that make it possible for thousands of banks and mortgage lenders to offer home financing.

In order for these banks and mortgage lenders to get their hands on Fannie and Freddie funding for their mortgage loans, they have to adhere to Fannie and Freddie’s rules when it comes to vetting mortgage loan applicants. And that means making sure borrowers have a reasonable ability to repay the loans that they are offered.

To find out how much borrowers can afford, Fannie and Freddie require that a borrower’s monthly housing expenses (that includes the new mortgage, property taxes, and any applicable mortgage insurance) to be no more than 43% of their gross monthly income.

On top of that, they will also look at other debt reported on your credit report, such as credit cards, car loans, and, yes, those student loans. You cannot go over 49% of your gross income once you factor in all of your monthly debt obligations.

For example, if you earn $5,000 per month, your monthly housing expense cannot go above $2,150 per month (that’s 43% of $5,000). And your total monthly expenses can’t go above $2,450/month (that’s 49% of $5,000). Let’s put together a hypothetical scenario:

Monthly gross income = $5,000/month

Estimated housing expenses: $2,150
Monthly student loan payment: $400
Monthly credit card payments: $200
Monthly car payment: $200

Total monthly housing expenses = $2,150

$2,150/$5,000 = 43%

Total monthly housing expenses AND debt payments = $2,950

$2,950/$5,000 = 59%

So what do you think? Does this applicant appear to qualify for that mortgage?

At first glance, yes! The housing expense is at or below the 43% limit, right?

However, once you factor in the rest of this person’s debt obligations, it jumps to 59% of the income — way above the threshold. And these other monthly obligations are not beyond the norm of a typical household.

What Can I Do to Qualify for a Mortgage Loan If I Have Student Debt?

So what can this person do to qualify? If they want to get that $325,000 mortgage, the key will be lowering their monthly debt obligations by at least $500. That would put them under the 49% debt-to-income threshold they would need to qualify. But that’s easier said than done.

Option 1: You can purchase a lower priced home.

This borrower could simply take the loan they can qualify for and find a home in their price range. In some higher priced real estate markets it may be simply impossible to find a home in a lower price range. To see how much mortgage you could qualify for, try out MagnifyMoney’s home affordability calculator.

Option 2: Try to refinance your student loans to get a lower monthly payment.

Let’s say you have a federal student loan in which the balance is $30,000 at a rate of 7.5% assuming a 10-year payback. The total monthly payment would be $356 per month. What if you refinanced the same student loan, dropped the rate to 6%, and extended the term to 20 years? The new monthly payment would drop to $214.93 per month. That’s a $142 dollar per month savings.

You could potentially look at student loan refinance options that would allow you to reduce your loan rate or extend the repayment period. If you have a credit score over 740, the savings can be even higher because you may qualify for a lower rate refi loan. Companies like SoFi, Purefy, and LendKey offer the best rates for student loans, and MagnifyMoney has a full list of great student loan refi companies.

There are, of course, pros and cons when it comes to refinancing student loans. If you have federal loan debt and you refinance with a private lender, you’re losing all the federal repayment protections that come with federal student loans. On the other hand, your options to refinance to a lower rate by consolidating federal loans aren’t that great. Student debt consolidation loan rates are rarely much better, as they are simply an average of your existing loan rates.

Option 3: Move aggressively to eliminate your credit card and auto loan debt.

To pay down credit debt, consider a balance transfer. Many credit card issuers offer 0% introductory balance transfers. This means they will charge you 0% interest for an advertised period of time (up to 18 months) on any balances you transfer from other credit cards. That buys you additional time to pay down your principal debt without interest accumulating the whole time and dragging you down.

Apply for one or two of these credit cards simultaneously. If approved for a balance transfer, transfer the balance of your highest rate card immediately. Then commit to paying it off. Make the minimum payments on the other cards in the meantime. Focus on paying off one credit card at a time. You will pay a fee of 3% in some cases on the total balance of the transfer. But the cost can be well worth it if the strategy is executed properly.

Third, if the car note is a finance and not a lease, there’s a mortgage lending “loophole” you can take advantage of. A mortgage lender is allowed to omit any installment loan that has less than 10 payments remaining. A car is an installment loan. So if your car loan has less than 10 payments left, the mortgage lender will remove these from your monthly obligations. In our hypothetical case above, that will give this applicant an additional $200 per month of purchasing power. Maybe you can reallocate the funds from the down payment and put it toward reducing the car note.

If the car is a lease, you can ask mom or dad to refinance the lease out of your name.

Option 4: Ask your parents to co-sign on your mortgage loan.

Some might not like this idea, but you can ask mom or dad to co-sign for you on the purchase of the house. But there are a few things you want to make sure of before moving forward with this scenario.

For one, do your parents intend to purchase their own home in the near future? If so, make sure you speak with a mortgage lender prior to moving forward with this idea to make sure they would still qualify for both home purchases. Another detail to keep in mind is that the only way to get your parents off the loan would be to refinance that mortgage. There will be costs associated with the refinance of a few thousand dollars, so budget accordingly.

With one or a combination of these theories there is no doubt you will be able to reduce the monthly expenses to be able to qualify for a mortgage and buy a home.

The best piece of advice when planning to buy a home is to start preparing for the process at least a year ahead of time. Fail to plan, plan to fail. Don’t be afraid to allow a mortgage lender to run your credit and do a thorough mortgage analysis.

The only way a mortgage lender can give you factual advice on what you need to do to qualify is to run your credit. Most applicants don’t want their credit run because they fear the inquiry will make their credit score drop. In many cases, the score does not drop at all. In fact, credit inquiries account for only 10% of your overall credit score.

In the unlikely event your credit score drops a few points, it’s a worthy exchange. You have a year to make those points go up. You also have a year to make the adjustments necessary to make your purchase process a smooth one. Do keep in mind that it is best to shop for mortgage lenders and perform credit inquiries within a week of each other.

You should also compare rates on the same day if at all possible. Mortgage rates are driven by the 10-year treasury note traded on Wall Street. It goes up and down with the markets, and we’ve all seen some pretty dramatic swings in the markets from time to time. The only way to make an “apples-to-apples” comparison is to compare rates from each lender on the same day. Always request an itemization of the fees to go along with the rate quote.

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Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Rafael Reyes
Rafael Reyes |

Rafael Reyes is a writer at MagnifyMoney. You can email Rafael here

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Mortgage

Should You Save for Retirement or Pay Down Your Mortgage?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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On the list of financial priorities, which comes first — paying off your mortgage or saving for retirement? The answer isn’t simple. On one hand, owning a home with no mortgage attached to it provides long term security knowing you’ll have a place to live with no monthly payment except property taxes and insurance. However, you’ll also need income to live on if you plan to retire, and how much you save now will have a big impact on your quality of retirement life.

We’ll discuss the pros and cons of whether you should save for retirement or pay down your mortgage, or maybe a combination of both.

Pros of paying down your mortgage vs. saving for retirement

The faster you pay your mortgage off, the sooner you own the home outright. However, there are other benefits you’ll realize if you take extra measures to pay your loan balance off faster.

You could save thousands in long-term interest charges

Most homeowners take out a 30-year mortgage to keep their monthly payments as low as possible. The price for that affordable payment is a big bill for interest charged over the 360 payments you’ll make if you’re in your “forever” home.

For example, a 30-year fixed $200,000 loan at 4.375% comes with a lifetime interest charge of $159,485.39. That’s if you never pay a penny more than your fixed mortgage payment for that 30-year period. Using additional funds to pay down your mortgage faster can significantly reduce this.

Even one extra payment a year results in $27,216.79 in interest savings on the loan we mentioned above. An added bonus is that you’ll be able to throw your mortgage-free party four years and five months sooner.

You’ll build equity much faster

Thanks to a beautiful thing called amortization, lenders make sure the majority of your monthly mortgage payment goes toward interest rather than principal in the beginning of your loan term. Because of that, it’s difficult to make a real dent in your loan principal for many years. You can, however, counteract this by making additional payments on your mortgage and telling the lender to specifically put those payments toward your principal balance instead of interest.

Not only do you pay less interest over the long haul with this strategy, but you build the amount of equity you have in your home much faster. And to homeowners, equity is gold — you’re closer to owning your home outright, and equity can also be a resource if you need funds for a home improvement project or another big expense.

You can access that equity as your financial needs change by doing a cash-out refinance or by taking out a home equity loan or home equity line of credit (HEL or HELOC).

You won’t lose your home if values drop

When you contribute extra money into a retirement account, there is always the risk that you’ll lose some or all of the money you invested. When you contribute money to paying off your mortgage, even if the values drop, you still have the security of a place to live, and are increasing the equity in the home, no matter how much it’s ultimately worth.

Making extra payments ensures you’ll eventually have a debt-free asset that provides shelter to you and your family, regardless of what happens to the housing market in your neighborhood.

Cons of paying down your mortgage vs. saving for retirement

There are some cases where paying down your mortgage faster might actually hurt you financially. Before adding extra principal to your mortgage payments, you’ll want to make sure you aren’t doing damage to your financial outlook with an extra contribution toward your mortgage payoff.

You might end up paying more in taxes

The higher interest payments you make during the early years of your mortgage can act as a tax benefit, so paying the balance down faster could actually result in you owning more in federal taxes. If you are in a higher tax bracket in the early (first 10 years) of your mortgage repayment schedule, it may make sense to focus extra funds on retirement savings, and let your mortgage interest deduction work for you. Of course, everyone’s tax situation is different, so you’ll have to decide (with help from an accountant ideally) if it makes sense to itemize your taxes in order to claim mortgage interest payments as a deduction.

You won’t get to enjoy the return on your paydown dollars until you sell

The only real benchmark for figuring out the value of paying down your mortgage is to look at how much equity you’re gaining over time. However, the equity doesn’t become a tangible profit until you actually sell your home. And the costs of a sale can take a big bite out of your equity because sellers usually pay the real estate agent fees.

Home equity is harder to access

The only way to access the equity you’ve built up is to borrow against it, or sell your home. Borrowing against equity often requires proof of income, assets and credit to confirm you meet the approval requirements for each equity loan option. If you fall on hard financial times due to a job loss, or are unable to pay your bills and your credit scores drop substantially, you may not be able to access your equity.

Pros of saving for retirement vs. paying down your mortgage

Depending on your financial situation and savings habits, it may be better to add extra funds monthly to your retirement account than to pay down your mortgage. Here are a few reasons why.

You may earn a higher return on dollars invested in retirement funds

The growth rate for a stock portfolio has consistently returned more than housing price returns. The average return in the benchmark S&P stock fund is 6.595% for funds invested from the beginning of 1900 to present, while home values have increased just 0.1% per year after accounting for inflation during that same time period.

Assuming your portfolio at least earns 7%, if you consistently invest your money into a balanced investment portfolio, you can expect to double your money every 10 years. There aren’t many housing markets that can promise that kind of growth.

Retirement funds are generally easier to access than home equity

Retirement funds often give you a variety of options for each access, with no income or credit verification requirements, and only sufficient proof of enough funds in your account to pay it back over time. For example, a 401k loan through the company you work for will just require you to have enough vested to support the loan request, and sufficient funds left over to pay it off over a reasonable time.

Just be cautious about making a 401k withdrawal, which is treated totally differently than a loan. You aren’t expected to pay it back like you would a 401k loan, but you could get hit with taxes and penalties.

Cons of saving for retirement vs. paying down your mortgage

You’ll need to weather the ups and downs of the market

Most people who have invested money in the stock market or tracked the performance of their 401k over decades have stories about periods when the value of those investments dropped substantially. While the 7% return on investment is a reliable long term indicator how much your retirement fund might earn, the path to that return is hardly linear.

For example, if you were considering retirement between 1999 and 2002, you may have had to delay those plans when the S & P plummeted over 23% in value in 2002. If you look at each 10-year period since the 1930s, every decade has been characterized by periods of ups and downs.

Calculating the benefit of paying down your mortgage vs. saving for retirement

If you’re torn as to what to do with that extra cash or windfall, let’s look at an example of someone who has an extra $200 to put into either their nest egg or their mortgage each month for the next 30 years.

For this scenario, we’re going to assume their retirement account earns an average 7% rate of return and that their mortgage loan balance is $200,000.

Here’s how much they’d save:

Savings From Paying $200 per Month Down on Your Mortgage
Years PaidMortgage Interest SavingsExtra Equity in HomeTotal Interest Savings and Equity Built Up
10 years$6,040$30,039$36,079
20 years$28,529$76,529$105,058
22 years 6 months$50,745$200,000$250,745

One thing you may notice about the mortgage savings chart — it includes how much extra equity you’re building. Often only the mortgage interest savings is cited when people look at how much you save with extra payments, but that ignores the fact that you’re building equity in your home much faster as well. So not only do you save over $50,000 in interest with your extra contribution, you replenish $150,000 of equity that was used up by your mortgage balance.

As you can see, adding that extra $200 to their mortgage principal each month saved them about $200,000 in the long haul — but the real savings don’t stop there.

By adding an extra $200 to their mortgage payment each month, this borrower turned their 30-year loan into a 22-and-a-half year loan and became mortgage debt-free seven years faster.

That means, in addition to saving $50,000 in interest savings and gaining $200,000 of equity, they also no longer have a mortgage payment. That frees up $998.57 per month that they can now use as discretionary income. That’s an extra $89,871 they could potentially save over that 7.5 year period.

When you add that to the $250,745.41 they saved on mortgage interest and earned in home equity, they’re looking at a total savings of $340,616.

That gives the mortgage paydown a $54,000 net positive edge over saving that extra $200 for retirement, as you can see in the table below.

Savings From Contributing $200 per Month to a Retirement Fund
Years PaidRetirement Balance
10 years$34,404
20 years$102,081
30 years$235,212

The one caveat for this retirement calculation is we assumed the saver was starting at a $0 investment balance. If they already had a healthy balance in their nest egg, they might actually come out in better shape than paying down their mortgage.

There are clearly benefits to each option, and you should consider running your own calculations with your real numbers to get the best answer for yourself.

Paying down your mortgage and saving for retirement at the same time

There’s a fair case to be made for both paying down your mortgage and saving more for retirement, but why choose? If you’re somewhat on track with your retirement savings goals, and like the idea of having your mortgage paid off quicker, you could allocate a certain amount to each.

Pick a number you feel comfortable paying to your principal every month, and then to your 401k, and put it on autopilot for a year. Any time your income increases, or you get bonuses, divide up the amount between principal pay down and retirement additions.

Let’s look at what happens if you evenly divide up your $200 per month between investing your retirement and paying down your mortgage. We’ll use the same $200,000 loan at 4.375% referenced above, and look at the lifetime results.

Savings From Paying $100 Down on Your Mortgage Until Paid Off
Years PaidInterest SavingsExtra Home EquityTotal Interest Savings and Equity Built Up
10 years$3,020$15,020$18,040
20 years$14,265$38,265$52,350
25 years$30,534$200,000$230,534
Savings From Contributing $100 to a Retirement Fund for 30 Years
Years PaidRetirement Balance
10 years$17,202
20 years$51,401
30 years$117,607

Balancing the $100 investment in both strategies still yields a six-figure retirement balance after 30 decades, a debt-free house after 26 years, and shaves off $30,000 in mortgage interest expense. If you don’t like putting all your eggs into one financial basket, this may balance the risks and rewards of each option.

Final thoughts

Looking at the short term and the long term may provide you with the best framework for making a good decision about how to spend dollars on retirement versus extra mortgage payments. Be wary of any financial professional that tells you one path is absolutely better than another.

Having a stable source of affordable shelter is equally as important as having enough income to live when you retire, so a balanced approach to paying down your mortgage and savings for retirement may help you accomplish both goals.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

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Life Events, Mortgage

What Is Mortgage Amortization?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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One of the biggest advantages of homeownership versus renting is each mortgage payment gradually pays off your mortgage and builds equity in your home. The difference between your home’s value and the balance of your loan is home equity, and your equity grows with each payment because of mortgage amortization.

Understanding mortgage amortization can help you set financial goals to pay off your home faster or evaluate whether you should refinance.

What is mortgage amortization?

Mortgage amortization is the process of paying off your loan balance in equal installments over a set period. The interest you pay is based on the balance of your loan (your principal). When you begin your payment schedule, you pay much more interest than principal.

As time goes on, you eventually pay more principal than interest — until your loan is paid off.

How mortgage amortization works

Understanding mortgage amortization starts with how monthly mortgage payments are applied each month to the principal and interest owed on your mortgage. There are two calculations that occur every month.

The first involves how much interest you’ll need to pay. This is based on the amount you borrowed when you took out your loan. It is adjusted each month as your balance drops from the payments you make.

The second calculation is how much principal you are paying. It is based on the interest rate you locked in and agreed to repay over a set period (the most popular being 30 years).

If you’re a math whiz, here’s how the formula looks before you start inputting numbers.

Fortunately, mortgage calculators do all the heavy mathematical lifting for you. The graphic below shows the difference between the first year and 15th year of principal and interest payments on a 30-year fixed loan of $200,000 at a rate of 4.375%.

For the first year, the amount of interest that is paid is more than double the principal, slowly dropping as the principal balance drops. However, by the 15th year, principal payments outpace interest, and you start building equity at a much more rapid pace.

How understanding mortgage amortization can help financially

An important aspect of mortgage amortization is that you can change the total amount of interest you pay — or how fast you pay down the balance — by making extra payments over the life of the loan or refinancing to a lower rate or term. You aren’t obligated to follow the 30-year schedule laid out in your amortization schedule.

Here are some financial objectives, using LendingTree mortgage calculators, that you can accomplish with mortgage amortization. (Note that MagnifyMoney is owned by LendingTree.)

Lower rate can save thousands in interest

If mortgage rates have dropped since you purchased your home, you might consider refinancing. Some financial advisors may recommend refinancing only if you can save 1% on your rate. However, this may not be good advice if you plan on staying in your home for a long time. The example below shows the monthly savings from 5% to 4.5% on a $200,000, 30-year fixed loan, assuming you closed on your current loan in January 2019.

Assuming you took out the mortgage in January 2019 at 5%, refinancing to a rate of 4.5% only saves $69 a month. However, over 30 years, the total savings is $68,364 in interest. If you’re living in your forever home, that half-percent savings adds up significantly.

Extra payment can help build equity, pay off loan faster

The amount of interest you pay every month on a loan is a direct result of your loan balance. If you reduce your loan balance with even one extra lump-sum payment in a given month, you’ll reduce the long-term interest. The graphic below shows how much you’d save by paying an extra $50 a month on a $200,000 30-year fixed loan with an interest rate of 4.375%.

Amortization schedule tells when PMI will drop off

If you weren’t able to make a 20% down payment when you purchased your home, you may be paying mortgage insurance. Mortgage insurance protects a lender against losses if you default, and private mortgage insurance (PMI) is the most common type.

PMI automatically drops off once your total loan divided by your property’s value (also known as your loan-to-value ratio, or LTV) reaches 78%. You can multiply the price you paid for your home by 0.78 to determine where your loan balance would need to be for PMI to be canceled.

Find the balance on your amortization schedule and you’ll know when your monthly payment will drop as a result of the PMI cancellation.

Pinpoint when adjustable-rate-mortgage payment will rise

Adjustable-rate mortgages (ARMs) are a great tool to save money for a set period as long as you have a strategy to refinance or sell the home before the initial fixed period ends. However, sometimes life happens and you end up staying in a home longer than expected.

Knowing when and how much your payments could potentially increase, as well as how much extra interest you’ll be paying if the rate does increase, can help you weigh whether you really want to take a risk on an ARM loan.

The bottom line

Mortgage amortization may be a topic that you don’t talk about much before you get a mortgage, but it’s certainly worth exploring more once you become a homeowner.

The benefits of understanding how extra payments or a lower rate can save you money — both in the short term and over the life of your loan — will help you take advantage of opportunities to pay off your loan faster, save on interest charges and build equity in your home.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

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