It’s true that missing payments or delinquencies on your student loans can negatively affect credit scores. However, the connection between student loans and credit scores is only a small part of the equation.

For most borrowers, the biggest impact of student debt is felt in the form of Debt-to-Income ratio analysis. Essentially, the larger your monthly student loan bills, the more difficult it can be to get approved for a mortgage.

This guide will cover how student loans can impact the Debt-To-Income ratio and explore the tools and strategies that borrowers can use to reduce or eliminate the impact of student loans on mortgage applications.

Student Loans and the Debt-to-Income Ratio

The debt-to-income ratio (DTI) is one of the most critical numbers in the mortgage application process. DTI is a calculation that compares how much you owe with how much you earn every month. Lenders use it to evaluate if you can afford to pay back a mortgage.

Lenders consider two DTI numbers. The first one is called the front-end ratio. The front-end ratio looks at how the mortgage payment you’re applying for compares to your monthly income.

Calculating the front-end ratio is relatively straightforward. Lenders will look at your expected monthly housing costs – this includes the anticipated principal, interest, property taxes, and insurance – and then divide that number by your monthly income before taxes. Tools such as the FHA Mortgage Calculator are excellent for estimating housing costs.

Here’s an example of the front-end ratio at work: Suppose the total expected housing costs are $1,000 per month and the applicant earns $5,000 per month. The front-end ratio would be .20 or 20% ($1,000/$5,000). Most mortgage companies prefer a front-end ratio below 28%, though some may accept up to 31% or slightly more under certain circumstances. It’s important to note that student loans don’t impact the front-end ratio.

The second DTI number that mortgage lenders look at is called the back-end ratio. This number is the one that causes headaches for student loan borrowers. Unlike the front-end ratio that considers only the expected housing costs, the back-end ratio calculates all monthly expenses compared to monthly income. Lenders typically want this ratio to be below 41%. That said, the highest acceptable back-end ratio can vary based on your credit profile. In some cases, lenders may approve ratios even above 50%.

The back-end ratio includes the following monthly bills:

• current housing expenses
• car payments
• student loan bills
• minimum monthly payments on credit cards
• any other debt that appears on a credit report

The back-end ratio DOES NOT include the following monthly bills:

• utility bills
• food and groceries
• cell phone bill
• cable bills
• retirement plan contributions to 401(k), IRA, and Roth accounts
• most subscriptions

One final note on back-end DTI calculations: Lenders usually take yearly income and divide it by 12. If you get paid every two weeks, take your paycheck, multiply it by 26 and then divide by 12 for your monthly income.

Strategies to Improve Debt-to-Income Ratios

Fixing the back-end DTI isn’t an easy task. Most borrowers can’t just snap their fingers and have less debt. However, there are ways to tweak the DTI to lower your ratio.

Pay Down Credit Card Balances – For most types of debt, paying down the balance doesn’t change your Debt-to-Income (DTI) ratio. For instance, even if you pay more than needed on your car loan, your monthly car payment doesn’t decrease. Accordingly, your DTI remains the same. However, paying down your credit card balance lowers your minimum monthly payment. The lower your credit card balance, the less you have to pay each month. The less you’re required to pay monthly, the better your back-end DTI becomes.

Change Repayment Plans – One of the perks of federal student loans is the variety of available repayment plans. By changing to a plan like SAVE or PAYE, borrowers can potentially lower their monthly payments. Suppose a borrower has $35,000 in federal student loans and they are on the standard repayment plan. According to the federal loan repayment simulator, the monthly payment used in the DTI calculation would be $389. If that borrower switches to the graduated repayment plan, the payment lowers to $222 per month. Even though the student loan balance hasn’t changed, by switching repayment plans, the borrower can improve their back-end DTI. Many borrowers will find the lowest monthly payment using the SAVE plan.

Eliminate Smaller Balances – We’ve established that lowering the balance on most loans won’t reduce your monthly expenses. But, paying off an entire balance can make a huge difference. Typically, we suggest that borrowers pay down their highest-interest debts first. However, one notable exception is when borrowers are trying to improve their DTI for a mortgage application. By paying off a smaller loan in full, even if it is a low-interest loan, the monthly payment disappears from the credit report. Thus, one less debt means a smaller back-end DTI.

Refinancing Student Loans for Mortgage Applications

Another way to better your Debt-to-Income (DTI) ratio is by refinancing your student loans. Refinancing means finding a new lender who agrees to pay off some or all of your current student loans. You then pay back this new lender based on the terms of your new loan agreement.

People usually refinance to get a lower interest rate on their student loans. But, if you’re refinancing to help you qualify for a mortgage, the main goal is to lower your monthly payments. For example, while securing a lower interest rate is beneficial, extending the length of your loan can have a much bigger impact on reducing your monthly payments.

Please note that refinancing student loans is different than temporarily picking a new repayment plan. Before refinancing, borrowers should consider several factors:

Be Extra Careful with Federal Loans – Federal student loans have excellent borrower perks, like income-driven repayment plans and student loan forgiveness. If you refinance your federal loans with a private lender, you’ll lose access to these benefits forever. You should only refinance federal loans if you’re confident you can pay back the entire loan without needing those federal programs.

Shop Around – It’s important to compare options. Talk to several lenders because each one has their own way of evaluating loan applications. To make sure you’re getting the best deal, it’s a good idea to check rates with different lenders. We recommend applying with at least five different lenders to see what offers you can get.

Don’t Delay – The entire refinance process can easily take longer than a month. Getting approved takes time. Having your new lender pay off the old debts takes time. Waiting for your credit report to show the old loans as paid off takes time. If you are going to refinance your student loans to help your chances at a successful mortgage application, be sure to do it long before applying for the mortgage.

Find the Best Long-Term Rate – If your goal in refinancing is to lower your monthly payments for a mortgage application, opting for a longer repayment term is a smart move. For example, choosing a 20-year loan term will give you significantly lower monthly payments compared to a 10-year term. Though the interest rate might be a bit higher, your monthly payments will be much more affordable. Keep in mind that the companies advertising the lowest rates are usually promoting their shortest-term loans. Focus on the lenders who have the best 20-year refinance rates.

Multiple Refinances – As you plan your strategy, remember that there is nothing wrong with refinancing your student loans multiple times. You might start with a long-term loan to reduce your payments before applying for a mortgage, then refinance again after buying your home to lock in a better interest rate. This approach can be creative way to work within the system, but it does involve some risks. You’re counting on being approved again and lower interest rates being offered in the future.

Mortgage Applications, Student Loans, and Credit Scores

Thus far, we have focused primarily on the DTI because this is typically how student loans make the biggest impact on a mortgage application. However, student loans can also affect credit scores (which can have an effect on mortgage applications). For example, longer credit histories typically help credit scores, and a student loan might be a borrower’s oldest line of credit. Additionally, making on-time payments can improve a credit score, while late payments and other student loan issues can damage it.

The process of refinancing has the ability to either help or hurt your credit score. In the vast majority of cases, the impact on credit score is minimal in either direction. It usually is difficult to predict the exact nature of the score change. Paying off multiple loans and consolidating them into one new loan can lead to an increase in your score. But, if your student loan is one of your oldest accounts, closing it and opening a new one can shorten your credit history and might lower your score a bit.

Refinancing applications can also cause a slight dip in the credit score. Fortunately, credit agencies generally count shopping around as a single application.

For these reasons, it is crucial to make any student loan moves well in advance of your mortgage application. This will ensure that any potential negative impacts are minimal while allowing you to take advantage of the positive consequences.

There are a couple of additional items to be aware of. First, for borrowers with excellent credit scores, the minor variations from the refinance process are unlikely to impact the amount offered or the interest rate on their mortgage. Second, if your lender has mistakenly reported any negative information to the credit agencies, be sure to get this adverse reporting fixed as soon as possible.

Working with Mortgage Brokers and Lenders

Because credit scores can be complicated, it is often a good idea to consult an expert. Mortgage brokers earn their living by helping people find mortgages. Some are better than others, and some are more reputable than others. Working with someone who is not only skilled but also trustworthy can greatly improve your chances of getting approved.

A knowledgeable mortgage expert can assist most student loan borrowers in understanding their financial position and what steps they might need to take to improve their chances of mortgage approval. They can help mortgage applicants answer the following questions:

• What size mortgage will I qualify for?
• Is my credit score going to be an issue?
• What ways can I improve my DTI?
• What price range should I be considering?

Where the mortgage brokers and lenders can fall short is in helping borrowers make a responsible decision. Determining how big a mortgage someone can qualify for is one thing, but determining whether it is a good idea is another matter. Just because you can qualify for the mortgage doesn’t mean you can afford it or that it’s a good idea. Brokers get paid when new loans are created, so they don’t have an incentive to tell you when a mortgage is a bad idea.

Another area where mortgage experts can often lack expertise is with student loans. Many mortgage lenders don’t fully understand how federal repayment plans work. This knowledge deficiency can make the underwriting process more difficult.

Underwriting Issues – Can I Use IBR, PAYE, or SAVE Payments?

Mortgage underwriting is the process by which lenders evaluate an applicant’s finances to determine whether or not they should offer a mortgage loan. This process also determines the interest rate and loan size.

Borrowers who use income-driven repayment plans for their federal student loans have historically found their plans to be a hurdle in qualifying for a mortgage. In the past, lenders would not accept income-driven payments for DTI calculations because the borrower’s payments could increase. Therefore, they concluded that the payments weren’t an accurate representation of that monthly expense.

Student loan borrowers and advocates argued that the only reason these payments would go up is if the borrower was earning more money. Borrowers making more money would be in a better position to repay their mortgage.

Nonetheless, for years, borrowers weren’t able to use income-driven payments for DTI calculations. Instead, lenders would replace the actual monthly payment with 1% of the loan balance. For borrowers with enormous debts, this would often shatter the DTI and lead to application rejections.

The good news is that most lenders are becoming more knowledgeable on this issue.

Mortgage giants like Freddie Mac and Fannie Mae have finally seen the light. They have updated their approach and are now more open to considering payments under income-driven repayment plans (like IBR, PAYE, or SAVE) when calculating your DTI. This new approach has also been adopted by many smaller lenders, like local credit unions and regional banks. However, not every lender is on board with including these types of payments into DTI calculations. For this reason, it is critical to communicate with your lender to determine how they evaluate income-driven payments on student loan applications.

To safeguard your home buying journey, we recommend applying for a mortgage with multiple lenders. This way, if one lender gets cold feet about your student debt close to the final decision, you’ll have another option already in progress.

Sherpa Tip: For many borrowers, the plan with the lowest monthly payment is the best plan to use if you are going to apply for a mortgage.

Special Rules for $0 Payments on Mortgage Applications

When applying for a mortgage, it’s important to understand that mortgage lenders typically do not consider $0 payments when calculating debt-to-income (DTI) ratios. Instead, they use a percentage of the existing loan balance. Historically, lenders used a flat 1% of the loan balance for these calculations. However, many lenders now use a more favorable 0.5% rate.

If you qualify for a $0 per month payment on your student loans, it may be beneficial to switch to a repayment plan that offers the lowest non-zero monthly payment. This strategy can present a more favorable DTI ratio to lenders, potentially improving your mortgage approval chances.

However, there are significant drawbacks to consider. Switching to a plan with a higher payment means spending more money on your student loans. Additionally, if you move away from an income-driven repayment (IDR) plan, you could lose valuable time toward student loan forgiveness. The process of changing repayment plans can also be cumbersome and time-consuming.

If you decide to change repayment plans for mortgage purposes, it is advisable to make the switch a few months before applying for the mortgage. This timing ensures that the new monthly payment appears on your credit report. Maintaining this mortgage-friendly payment plan until the loan closes is wise, as lenders may conduct another credit check at that point. After closing on the house, you can switch back to the plan offering a $0 per month payment, assuming you still qualify.

Given the complexities involved in tweaking repayment plans and mortgage eligibility, consulting with several mortgage professionals is a prudent step. Explain your available repayment plans and discuss your options. While the extra steps of changing repayment plans may not be necessary in every case, for those with substantial student loan balances, it could be the key to securing the mortgage you want.

Co-Signer Issues on Mortgage Applications

Being a co-signer on a student loan can also impact your mortgage application. Co-signed student loans appear on your credit report, along with monthly payments. Consequently, most lenders include the co-signed loan payment in DTI calculations, even if you aren’t the one who makes the student loan payments.

Many lenders will remove the co-signed loan from the DTI calculation if you can show that the student loan borrower has been making payments independently for a while, usually 12 to 24 months. However, since many mortgage applications are initially reviewed by a computer algorithm, co-signed loans could still trigger a rejection, regardless of the primary borrower’s payment history.

Things get further complicated for co-signers of borrowers still in school. We have heard of lenders going so far as to initiate a three-way call between the mortgage applicant, the mortgage company, and the student loan company. The mortgage company essentially asks the student loan company to determine the maximum potential payment once the borrower graduates and enters repayment. This maximum payment is then used in the DTI calculations, potentially affecting the co-signer’s mortgage application significantly.

Accordingly, if you’re thinking about buying a house in the future, you should probably avoid co-signing on student loans if possible.

Next Steps to Fix Student Loan Debt on Your Mortgage Application and Buy a Home

The following steps could help you qualify for a home loan. Because student loan changes can take months to be reflected in your credit report, you should plan ahead.

Visit the Federal Repayment Simulator – Review the repayment plan options to get the lowest monthly payment.

Refinance Private Loans – The best way to improve debt-to-income ratios for private loan debt is to pick a 20-year loan at the lowest interest rate possible. Borrowers can probably refinance again after securing a mortgage.

Try to get a Co-Signer Release – If you have co-signed a student loan for someone else, getting removed from that loan should be a priority.

The post Student Loans and Mortgages: The Impacts and Strategies for Homebuyers appeared first on The Student Loan Sherpa.

If there is good news in this challenging situation, many borrowers can take simple steps to improve their application.

Picking the right student loan repayment plan isn’t just about keeping things affordable or qualifying for loan forgiveness. The right student loan repayment selection can turn a mortgage application rejection into an approval.

Debt-to-Income Ratios: The Reason Repayment Plan Selection is Critical

One of the most important figures on any mortgage application is the debt-to-income ratio.

The Debt-to-Income Ratio or DTI looks at a would-be borrower’s monthly income compared to their monthly debts. Many people mistakenly assume that this number is pretty much set in stone. Fortunately, student loan borrowers can improve their DTI without paying off a loan in full or getting a raise.

Because mortgage companies use credit reports to determine debts, the monthly bill reported by lenders and federal servicers is critical. Thus, picking the right repayment plan can make a massive difference in the DTI analysis.

Sherpa Thought: At the risk of repeating myself, borrowers must understand that monthly debts and income matter far more than total debt or yearly income.

In other words, a borrower with a $500 monthly bill for a $5,000 loan balance will get treated the same as a borrower with a $500 monthly bill for a $100,000 loan balance.

It might sound ridiculous, but mortgage companies follow strict standards and formulas when underwriting. The monthly payment is critical, and the interest rate and total balance don’t really matter.

The New SAVE Plan Makes it Easier to Buy a Home

The New SAVE plan is the most generous Income-Driven Repayment Plan currently available.

Borrowers get to keep a larger percentage of their income, and the discretionary-income calculation has been further tweaked in favor of borrowers.

For many, the result is a much more affordable monthly payment.

Thus, signing up for SAVE could mean a much lower monthly bill and improved odds of qualifying for a home loan. To estimate your monthly bill on SAVE, use this SAVE calculator.

What if I want to pay more each month so I don’t spend a ton of money on student loan interest? Some borrowers have avoided SAVE because they wish to pay off their debt quickly.

However, this approach is usually a mistake. Borrowers can pay extra toward their federal loans whenever they want. The monthly bill is the minimum monthly payment. There isn’t a penalty for paying extra to knock out the debt faster.

Changing IDR Payments and Mortgage Lender Nonsense

Historically, some mortgage lenders refused to accept monthly payments on IDR plans like SAVE. They reasoned that because the IDR payment could go up, it wasn’t a reliable number to use for DTI analysis.

Thankfully, common sense has mostly prevailed. Lenders now recognize that a monthly payment would only increase if the borrower earned more money.

However, it is worth noting that different banks and lenders may have unique rules and standards. The policies outlined in this article apply to most lenders, but your local bank or credit union might have a strange student loan policy. If that is the case, moving on to a more reasonable lender is often the easiest fix.

The Danger of Income-Driven Repayment Plans like SAVE

Even though most lenders will now accept IDR payments for DTI calculations, there is one circumstance where they revert back to the older and more harsh rules.

If you qualify for $0 per month student loan payments, many lenders will refuse to accept the $0 payment for DTI calculations. Instead, they will use .5% or 1% of the total loan balance. For example, a borrower with a $0 per month payment and a $50,000 student loan balance will get treated as though they have to pay $500 or $250 per month on their student loan.

For borrowers with sizeable federal student loan balances, qualifying for a $0 per month payment may tank a mortgage application.

Thus, if you are going to apply for a mortgage in the next year, the best repayment plan to select is the one with the lowest monthly payment, as long as it is above $0.

To see projected payments across all federal repayment plans, use the Department of Education Loan Simulator.

Plan Selection Alert: Some borrowers may find that the graduated or extended repayment plans offer the lowest monthly payment and best chances at a mortgage approval.

Because these older plans do not qualify for PSLF or IDR forgiveness, borrowers who use these plans for mortgage applications should switch back to their desired IDR plan as soon as the home closes.

Don’t switch back too early and have it mess up your closing. Running a credit check just before signing is common, and a new loan or new payment can cause issues.

Repayment Plan Selection for Private Loans

Private loans are notoriously more difficult than federal loans when it comes to repayment plan selection.

Income-driven repayment plans are not available, and borrowers have little say in their monthly bills.

A deferment or forbearance usually doesn’t help because mortgage lenders will use .5% or 1% of the loan balance for DTI calculations.

Despite these limitations, calling your private lender to ask about repayment plan options is often helpful. Switching from a 5-year repayment length to a 10-year repayment length would mean a significant drop in your monthly bill. Just be sure that your private lender reports the new lower monthly payment to the credit bureaus.

Digging Deeper: Tweaking monthly payments by selecting a new repayment plan isn’t the only move available to student loan borrowers who want to buy a home. Other strategies to prepare student debt for mortgage applications include removing cosigners and targeting individual loans.

Refinancing Private Loans for a Better DTI

One option to dramatically reduce the monthly bill on private loans is to refinance the debt.

Suppose a borrower has a $30,000 private student loan on a 10-year repayment plan. If the interest rate is 6%, the monthly payment will be just over $333. If that same loan gets refinanced into a 20-year loan at the same interest rate, the monthly payment drops to about $215.

Reducing the monthly bill by over $100 means the borrower can qualify for a large home loan. It could even be the difference between an approval or a rejection of a mortgage application.

The downside to this approach is that opting for a longer loan can sometimes mean a slightly higher interest rate.

Additionally, borrowers should use this option with care. Waiting until the last second to refinance your private loans can complicate the underwriting process on the home loan. Generally speaking, it is best to refinance at least a couple of months before starting mortgage applications. Talk with your desired lender to figure out an ideal timeline.

As of November, 2024, the following lenders offer the best interest rates on 20-year fixed-rate student loans:

Rank	Lender	Lowest Rate	Sherpa Review
1		6.08%*	Splash Financial Review
2		6.53%	ELFI Review
3		6.55%	Laurel Road Review

The post The Best Student Loan Repayment Plan for Getting a Mortgage and Buying a House appeared first on The Student Loan Sherpa.

However, focusing on student loans could mean putting off homeownership for years or even decades.

Finding an optimal strategy for balancing a desire for home ownership with your need to eliminate student debt isn’t easy. There isn’t a simple answer, and there isn’t an equation that will spit out the right decision.

The good news is that student loans don’t necessarily mean you can’t buy a home, and saving for a home doesn’t mean you have to be irresponsible with your student loans.

If you ask the right questions, you can find a realistic strategy that best fits your needs.

Interest Rate Considerations

Interest rates are vital when deciding whether to save for a down payment or eliminate debt.

If your savings account offers a 1.20% interest rate and your student loan charges a 9.60% interest rate, it might seem like paying down student debt is the obvious decision.

However, our analysis doesn’t end with a simple rate comparison.

For example, you could move your money to a different bank that offers a better interest rate. Some banks are now paying over 5% on savings accounts and CDs.

Likewise, there are options for student loans. If you have federal loans, paying the minimum and working towards forgiveness might be the best approach. If you have private loans, refinancing the debt with a new lender could lower the interest rate considerably.

In other words, even if you currently have a brutally high student loan interest rate and an atrociously low savings account interest rate, there are fixes available.

Your Goals Matter

The math on whether or not home ownership is a good idea is notoriously tricky.

The simple version is that the longer you stay in your house, the more it makes sense to buy.

Some factors go beyond building assets. You might want to live closer to family or work. Owning a home might be a major life goal.

If buying a home is important to you, it should be a consideration. Your happiness matters.

I’m not saying you should ignore your student loans and buy whatever makes you happy. Instead, I’m saying that your non-financial priorities also matter.

Sherpa Thought: A lot of personal finance advice makes judgments about right and wrong.

While some moves are objectively bad ideas or inherently risky, in many other cases, it comes down to personal preferences. The right decision for you may not be right for someone else.

When Student Loans Should Ge Paid Off First

There are situations where addressing your student debt is an obvious choice.

You might have so much student debt that you cannot qualify for a mortgage. If student loan payments eat up 40% of your income, there probably isn’t room for a home loan, and a mortgage company won’t lend you any money.

This doesn’t necessarily mean that you have to pay off all of your student loans, but it does mean that eliminating some of those loans may be required.

If you are in this situation, talking to a mortgage lender might be a good idea. Discuss which loans are the biggest issue on your credit report. It won’t necessarily be the loan with the highest interest rate. Sometimes it makes sense to attack a loan with a small balance but a large monthly payment.

Figure out the loan that is the biggest issue and attack it.

You can revisit the home mortgage question once your student debt situation becomes more manageable.

Student Loans Could be an Afterthought

In some cases, your student loan balance doesn’t matter.

Suppose you have over $100,000 of student loan debt. If that debt is federal and you work towards forgiveness, student loans shouldn’t change your plans.

Your monthly student loan payment will impact your Debt-to-Income ratio and potentially reduce home buying power. However, this situation may not change for over a decade.

Student debt will probably make buying a home more of a challenge, but paying them off first, or paying extra, doesn’t make sense.

Sherpa Tip: Sometimes, changing repayment plans is the only step needed to get student loans ready for a mortgage application. In many cases, picking the right repayment plan makes qualifying for a mortgage significantly easier.

Strategy for Borrowers Caught in the Middle

If you don’t fall into one of the aforementioned categories, figuring out the best approach can be complicated.

In this instance, I’d suggest building up a large emergency fund. For starters, having an emergency fund isn’t just a luxury — it is a necessity.

This exercise can provide valuable insight into the down payment question. You might look back after a few months and see that saving isn’t going well, and it is better to focus on your debt. You might also discover that you are doing well saving, and a down payment is a reasonable goal.

If your emergency fund grows beyond what is necessary, you can either use the money for the down payment on your mortgage or knock out a huge chunk of student debt.

There isn’t a substitute for personal experience, and spending several months saving can provide valuable insight. Plus, that emergency fund could come in handy.

Tips and Other Items to Consider

• You don’t need a 20% down payment. The conventional wisdom used to be that you needed a 20% down payment because it avoided PMI. For a student loan borrower, this is an especially difficult goal. Setting aside 3-5% may be sufficient for your needs.
• Don’t forget other debts. If you have credit card debt charging 20%, that is item number one on your to-do list.
• Make sure home ownership is right for you. Some people prefer to rent. Others have to move often for work. Buying a house and selling it a year later is usually a costly mistake.
• Use this time to learn. While you are getting your finances in order, take the opportunity to learn. Talk to mortgage lenders. Find a buyer’s agent and start looking at homes.

Most importantly, take a detailed look at your student loans and figure out how to optimize them for the mortgage application process.

The post Should I Save for a Home Down Payment or Pay Off Student Loans? appeared first on The Student Loan Sherpa.

With mortgage rates and house prices on the way up, home ownership may seem out of reach. These challenges hit student loan borrowers especially hard.

If there is good news in this situation, it is that not all hope is lost. The borrowers who understand how their student loans impact mortgage applications can tweak their repayment strategy to increase their purchasing power.

Student Loans, Interest Rates, Inflation, and the Most Important Number for Getting a Mortgage

I find that student loan borrowers often overestimate the importance of credit scores for mortgage applications.

While your credit score is an essential element to qualifying for a mortgage, it isn’t the most important one. The most critical number in the mortgage approval process is your Debt-to-Income Ratio or DTI.

When lenders look at your DTI, they look at home much you have to spend each month on your existing debts and your potential house payment. Then, they compare it to how much you earn each month. If the lender decides your salary isn’t sufficient to handle your current bills and the mortgage you want, you won’t be approved for the loan.

The changing economic climate hurts all mortgage applications. Higher interest rates and higher home prices mean larger mortgage payments for all homes.

Things hit student loan borrowers especially hard because these same factors cause havoc on their student debt in several different ways.

Sherpa Tip: One way to combat the tough economic climate is to make sure you prepare your student debt before applying for a mortgage. The best repayment plan for getting a home loan is usually the SAVE plan, but it will depend on the borrower’s income and loan balance.

Monthly Student Loan Payment Changes

Borrowers with variable-rate student loans are hit hardest by the connection between inflation, rising interest rates, and student loans.

As interest rates increase to combat inflation, variable-rate student loan interest rates also increase. Higher interest rates mean higher monthly student loan bills. Student loan lenders report the higher monthly bills to the credit agencies.

When a mortgage lender looks at your monthly debts for DTI calculation, this higher monthly bill reduces your chances for approval and the size of the mortgage you can get approved.

Sherpa Tip: Many borrowers can lock in a fixed-rate loan to prevent variable-rate student loan increases. The options vary based on your loan type, and don’t work for everyone. However, many borrowers can lock in a fixed-rate loan to prevent increasing interest rates from hurting their approval chances.

Federal Payment Formulas are Slow to Respond to Inflation

Each month the cost of gas, groceries, and rent increases. Inflation hurts because your paycheck doesn’t go as far as it once did.

In theory, federal student loan payments are designed to stay affordable for borrowers. If you enroll in an IDR plan, your monthly payment is calculated based on your discretionary income.

Sadly, one of the problems with IDR calculations is that they respond slowly to inflation. The IDR formula for discretionary income is updated once a year. During times of heavy inflation, things can change quickly in six months.

For borrowers, this dynamic means that as their budget tightens, the IDR payment consumes a larger portion of their actual discretionary income. This makes it harder to save for a down payment and to eliminate other debts.

Making Sure Student Loans Don’t Wreck Mortgage Applications

The economic climate makes it harder to buy a house and makes student loans even more devastating.

Fortunately, the tactics to clean up student loans for mortgage applications work in any environment.

Things have undoubtedly gotten harder, but that doesn’t mean student loan borrowers can’t become homeowners.

The post How Inflation, Rising Interest Rates Make it Harder for Student Loan Borrowers to Buy a House appeared first on The Student Loan Sherpa.

The process is called a “cash-out” mortgage. Instead of refinancing the amount currently owed on a house, in a cash-out refinance, homeowners borrower more than what they owe. This means they potentially get a large check at closing.

This option could be very tempting to student loan borrowers with higher interest rates. Someone who owes $140,000 on a house valued at $200,000 could do a cash-out refinance for $160,000. By going this route, the borrower can refinance their home at a lower interest rate, and get a check for $20,000 (minus closing costs) and use that money to pay down student loans.

Using a cash-out refinance could work in certain circumstances, but it comes with risks, and it may not be the best option for most borrowers.

Monthly Savings from Using a Mortgage to Pay Student Loans

Converting student loan debt to mortgage debt can provide a noticeable boost to monthly cash flow.

Generally speaking, monthly loan bills can be lowered in one of two ways: lower interest rates and longer repayment length. A cash-out refinance often accomplishes both. Interest rates can be reduced to the 3-4% range, and monthly payments are essentially spread out over 30 years.

To illustrate the potential savings, suppose we have a borrower with $10,000 of student loan debt at 7% interest on a 10-year repayment plan. By utilizing some of the equity that the borrower has built up, the borrower can get a $10,000 check in a cash-out refinance at 4% on a 30-year fixed-rate loan. In short, our hypothetical borrower has about half the original interest rate and gets 20 extra years to repay the debt.

In this example, our borrower would be making $116 payments on the student loan. If the debt were wrapped into the mortgage through a refinance, the extra $10,000 borrowed would increase the mortgage payment by just $47 per month. That provides an extra $69 per month in cash flow.

A borrower who takes the same steps with $50,000 in student loans would free up over $300 per month!

Another advantage is that the mortgage interest deduction is better than the student loan interest deduction for many borrowers. The student loan interest deduction has income restrictions and a lower deduction maximum. Generally speaking, mortgage interest is preferable at tax time, but the recent 2018 Tax Cuts and Jobs Act (better known as the Trump tax cuts), may change calculations for some borrowers.

However, the monthly cash flow and potential tax advantages come with some financial downside.

The negative is that by spreading out the payments over 30 years instead of just 10, the total spending on interest will be increased. By adding the $10,000 to the mortgage, it will result in an extra $7,187 in interest spending. Had the borrower stuck with the original 10-year repayment plan at 7% interest, the total interest spending would have been $3.933. In short, the longer it takes to repay the loan, the more you spend on interest… even if you have a noticeably better interest rate.

There are also risks to using a cash-out refinance to convert student loan debt into mortgage debt.

Secured Loan Risks

Student loan debt is considered to be unsecured debt. This means that the debt is not secured to any asset or collateral owned by the borrower. If a student defaults on their student loans, their education cannot be taken away.

A mortgage is a classic example of secured debt. If the borrower fails to make mortgage payments, the borrower risks foreclosure. Not making house payments can mean losing the house to the bank.

Adding extra debt to a mortgage means a higher payment. A larger payment is more difficult to handle during a financial hardship.

In other words, borrowers who add student debt to their mortgage risk losing their house because of student debt.

Student loan borrowers can make individualized assessments as to the danger of the student debt leading to a mortgage default. Still, it is something that all borrowers should carefully consider and weigh the risks.

Traditional Student Loan Refinancing vs. a Cash-Out Mortgage

A cash-out mortgage refinance can’t be discussed in a vacuum. Credit-worthy borrowers have multiple options to lock in lower interest rates on their student loans.

In a traditional student loan refinance, sometimes called loan consolidation, borrowers find a new student loan lender to pay off their old student loans. The borrower then repays the new lender according to the terms of the new loan. This approach can often yield significantly reduced interest rates and/or a longer repayment period.

A big advantage to a student loan refinance over a cash-out mortgage refinance is the savings on transaction costs. A student loan refinance has no transaction costs, while a mortgage refinance usually costs thousands of dollars. Expenses that are included in mortgage closing costs like title insurance, recording fees, and appraisals don’t exist with student debt.

Another advantage of traditional student loan refinancing is that the debt doesn’t get combined with the mortgage. This reduces the chances of student debt leading to foreclosure and losing your house.

From an interest rate perspective, the student loan refinance companies are surprisingly competitive with mortgage refinance rates. The refinance rates with many lenders currently start below 2%. However, these excellent rates are limited to 5-year variable-rate loans.  The 30-year fixed-rate mortgage offers a borrower far more flexibility. The closest apples-to-apples comparison on rates is to look at the 20-year fixed-rate student loan refinance as it is the longest repayment period that most lenders will allow. In the 20-year fixed-rate category, rates start just under 5%.

Ultimately, the mortgage refi will have better rates and a longer repayment period. The student loan refinance will save thousands from day one because there are no closing costs. Borrowers will have to weigh the interest rate difference against the closing costs when making a final decision.

One Other Option: Borrowers also have the option of using a Home Equity Line of Credit to pay off their student loans. Using this line of credit will normally have lower closing costs than a mortgage refinance, but the interest rate will usually be worse. This line of credit is also a secured debt, so it carries many of the same risks as a cash-out refinance.

Cash-Out Mortgages and Student Debt: Final Thoughts

Using home equity to eliminate student debt can be very appealing, especially when mortgage rates are near record lows.

Unfortunately, there are issues. Even though the borrower is saving some money on interest each month, by stretching out payments over 30 years, the total interest spending ends up being much higher. Combine the higher total spending with closing costs and risk of foreclosure, and the cash-out refinance suddenly looks much less appealing.

This is a financial move that might work out for some student loan borrowers, but most will likely be better off with aggressive repayment or a traditional student loan refinance.

The post Using a Cash-Out Mortgage Refinance to Pay Down Student Loans appeared first on The Student Loan Sherpa.

Cosigned student loans can be a considerable hurdle on a mortgage application. For some applicants, they can lead to higher interest rates, a lower total qualification, or even an outright denial.

Minimizing the impact of a cosigned student loan can require a bit of paperwork. In many cases, however, the effort can help the cosigner overcome the negative consequences.

Why cosigning student loans is a problem: The Debt-to-Income Ratio (DTI)

Cosigned student loans show up on the credit reports for both the primary borrower and the cosigner. Unfortunately, these reports do not clearly identify the individual as one or the other. Moreover, most lenders don’t really distinguish between the two roles. They assume, at least initially, that if a borrower could be responsible for the debt, the borrower will be responsible for it.

While there are ways to challenge this assumption, a major hurdle is that much of the underwriting process is automated. Lenders use pre-determined formulas to decide whether to approve an applicant and how much the applicant can borrow. A cosigned loan will influence these formulas.

A cosigned loan adds to the monthly debt amount listed on the cosigner’s credit report. This, in turn, affects the cosigner’s Debt-to-Income ratio (DTI). Consequently, the more debt listed, the more income the cosigner needs to qualify for the requested mortgage.

[Further Reading: Fixing Debt-to-Income Ratio Issues Caused by Student Loans] 

Removing cosigned loans from mortgage application calculations

The good news for cosigners applying for a mortgage is that it’s possible to exclude cosigned student loans from their debt calculations. However, the process can be somewhat tedious.

Simply explaining that the student loan listed on the credit report is a cosigned loan usually isn’t enough. Lenders typically require proof that the primary borrower is the one making the student loan payments. For instance, they may require documentation showing timely payments made for at least the past 12 months. Additionally, the cosigner may need to demonstrate that the primary borrower is the one making the payments.

The specifics of this underwriting process varies from one lender to the next. Mortgage applicants should be prepared to provide comprehensive documentation that demonstrates the primary borrower’s consistent payment history and ability to continue making payments in the future. This will help in ensuring that the cosigned loan does not negatively impact the mortgage application.

Removing a cosigner from the student loan

Rather than trying to convince a mortgage company to overlook a student loan on the cosigner’s credit report, a more practical solution might be to remove the cosigner from the student loan altogether.

There are a few ways to remove a cosigner from student debt:

Cosigner Release – Many student loan lenders have cosigner release policies. Under these programs, if the primary borrower makes consistent payments for a certain period (usually 12-36 months) and passes a credit check, the lender may release the cosigner from the debt. Unfortunately, there is little incentive for student loan companies to actually grant these requests. Lenders prefer to have two people legally responsible for the debt instead of just one.

Refinancing the Loan – Primary borrowers with a decent credit score and a job may be able to refinance the student loan. Through the refinance process, the refinancing lender pays off the original cosigned loan in full. The refinancing lender then creates a new student loan, ideally without a cosigner. The primary borrower may be able to get a lower interest rate or lower monthly payments through this process. Additionally, if the primary borrower doesn’t need the cosigner for the new loan, the cosigner will no longer be liable for the debt, and it will eventually fall off their credit report.

Refinancing with a New Cosigner – When refinancing a loan, there is no requirement to use the same cosigner. Regardless, a cosigner will likely be necessary if the primary borrower is unemployed or has a negative credit history.

Regardless of the approach used to remove the cosigner, it’s essential for mortgage applicants to plan ahead. Getting approval for a cosigner release or a refinance can take weeks or even months. Additionally, it will take some time for the lender to report the cosigner’s change in status to the credit bureaus.

Dealing with students still in school

For individuals who have cosigned student debt for primary borrowers still in school, the options for alleviating the impact of the debt on their financial profile are more limited.

Lenders rarely grant cosigner releases for in-school students. Refinancing usually isn’t an option, either. Furthermore, because repayment hasn’t begun on the loan, the mortgage applicant won’t be able to show that the primary borrower can handle the loan on their own.

Often, the credit report will not even show a monthly payment amount for such loans. When this happens, mortgage companies will sometimes estimate the monthly payment to calculate the DTI. Typically, these companies will use 1% of the total loan value as a stand-in for the monthly payment. Other mortgage companies set up a three-way call between the applicant, the mortgage company, and the student loan company. They will determine what the maximum monthly payment on the loan might be. The mortgage company then uses the maximum possible payment for making DTI calculations and underwriting decisions.

These scenarios underscore why cosigning a student loan can complicate financial matters for cosigners, particularly those who might be looking to purchase a new home before the borrower graduates. Cosigners in such situations should be fully aware of these complications and consider their need for future credit before agreeing to cosign.

Cooking the books

Indeed, when calculating DTI for mortgage applications, the total debt amount is less important than the monthly payment amount. This focus provides an opportunity to adjust monthly payments to lessen the impact of cosigned debt on mortgage eligibility.

There are two primary ways to lower payments:

Change repayment plans – Many student loans offer multiple repayment options. If the primary borrower switches to a plan with a longer repayment term, the monthly payments will be lower because the debt is spread out over a longer period. This reduction in the monthly payment amount can help improve the cosigner’s DTI ratio, enhancing their chances of qualifying for a mortgage.

Refinance the debt with the cosigner – In an ideal world, the cosigner wouldn’t be involved in the refinanced loan, completely removing them from the obligation. However, when the borrower can’t get approval on their own, and no other cosigners are available, a refinance can still help. By refinancing with a lender offering a lower interest rate or longer repayment length, the cosigner can improve their mortgage application.

Getting started early

Indeed, while there are various strategies to mitigate the impact of cosigned student debt on mortgage applications, a common challenge across all options is time. None of these strategies will provide an immediate resolution, and many can take several months to effectuate significant changes.

It’s crucial for cosigners to contact the primary borrower as soon as possible to discuss and develop a plan. The sooner you start, the more time you have to implement a strategy that may help improve your financial standing for a mortgage application.

For those already in the process of applying for a mortgage, proactive communication with your mortgage lender is essential. Discuss the presence of the cosigned debt and any steps you’re taking to manage it. Some lenders may be flexible or offer guidance on how they handle cosigned debts in their DTI calculations.

Since adjusting the impact of a cosigned loan can take time, planning for potential delays in the mortgage approval process is wise. This might mean starting your mortgage application earlier than initially planned or preparing for a longer wait time before approval.

By understanding these timelines and starting discussions early, cosigners can better navigate the complexities of managing cosigned student debt when applying for a mortgage, thereby ensuring smoother transitions and clearer communications with all parties involved.

The post Navigating Cosigned Student Loans and Mortgage Applications appeared first on The Student Loan Sherpa.

While we have heard of many extreme measures taken to pay off student loans, this one might take the cake.

The idea of parting with your home to have a zero balance on your student loans seems a bit desperate, but does it make sense?

Opportunity Cost of Selling Property

Eliminating a mountain of student debt can save thousands of dollars a year in interest alone. From this standpoint there is a huge financial incentive to knock out the debt. However, putting your home on the market comes with a number of costs that also have to be factored in.

For starters, you need a place to live. While trading student loan interest rates for mortgage interest rates may seem like an improvement (more on that a bit later), there are a ton of other costs associated with any move. Not only do you have moving expenses, but listing and selling a home usually means paying a real estate agent. The cost of a housing transaction is very expensive and must be factored into your math.

Even if you can live in mom and dad’s basement or on a friend’s couch, these options are ultimately temporary.

If the next step isn’t buying a house or condo, it could mean that renting is in your near future. Renting has its perks, but it can be very expensive compared to living in a house you already own.

Mortgage vs Student Loan Debt

If you are thinking about selling a piece of property, paying off your student loans, and then buying another piece of property for approximately the same price; you are essentially talking about trading student loan debt for mortgage debt. There are major implications here.

Perhaps most importantly, failure to pay your student loans won’t get you kicked out of your house.

If you fall behind on your mortgage, foreclosure is a possibility. While there are some programs out there for people having trouble paying their mortgage, these programs are not nearly as good as those available for student loans. For example, if you have federal loans, you can have payments of $0 per month, or have your loans forgiven in as little as 10 years under public service student loan forgiveness. Even private loans have programs that can get your interest rate reduced.

That all being said, there are some reasons mortgage debt is slightly better to have over a student loan. Not only are interest rates normally a bit lower (in part because the debt is secured — i.e. they can take your home if you fail to pay), but mortgage interest is also tax deductible. The tax benefits associated with a mortgage are usually better than those for student loans.

The Emotional Perspective

For most people, their house is more than just a number on a balance sheet or an asset.

It is home.

Being able to claim ownership of your little piece of the world has a value that can’t be easily quantified.

While paying off student loans definitely has a certain appeal to your stress level, a blank balance sheet hardly compares to the security of a roof over your head.

Other Options

In the opinion of this writer, selling your home should be something of a last resort. Before even considering going this route, other possibilities should first be investigated.

• Can you rent out your property and use the profits to pay down your student debt?
• Is a home equity loan an option? (This route also has tremendous risk, but it does have some of the advantages without the transaction costs of selling your home.)
• Have you explored the student loan forgiveness options for your federal loans?
• Have you looked into consolidating your loans on the private market to lock in lower interest rates?
• Is getting a roommate a possibility?

One Final Thought

If one year from now you got a better job, would your decision still be a good one?

A willingness to savagely attack your student loans is a good thing, but it shouldn’t be your only priority. Think about the different ways your life could change over the next decade. For each potential path ahead of you, consider how your choice could affect things.

The more analysis you can do before making the decision, the better your decision will be.

The post Should I sell my Condo to pay off my student loans? appeared first on The Student Loan Sherpa.

Some student loan borrowers struggle to set aside money for a down payment. Others struggle to get approval on a mortgage because of their existing debt.

In many ways, these are the lucky borrowers. Some student loan borrowers haven’t even bothered to apply for a mortgage because homeownership is nothing more than a dream with little chance of ever becoming reality.

Today we are going to try to answer two very important questions:

1. How does student loan debt affect a borrower’s ability to buy a home?
2. What is the collective impact of student loans on the housing market?

The numbers tell a very bleak story.

Symptoms of the student debt issue on the housing market… the Statistics

More and more children are living at home with their parents.

A decade ago just 12% of 25-34 year olds lived at home. That number has jumped to 17%. Things are even worse for males in this age group. More than 1 in 5 men age 25-34 are living at home. This is the highest percentage since the great depression.

Living at home isn’t the only housing change caused by student debt. Many graduates burdened by large student loan balances have fled to urban areas to seek higher-paying jobs. The loss of youth and of educated workers has hurt rural areas.

Some might argue that these changes in behavior can be attributed to factors outside student debt. To be fair, there certainly isn’t one single factor driving the numbers. That being said, there should be no dispute that student loans are a significant contributing factor.

A study by the United States Federal Reserve found that 400,000 would have bought homes in the last year, but did not because of student loans. A separate real estate group study pegged the number at 414,000. The real estate group calculated that the lost home sales totaled $83 billion. According to Director of Research Rick Palacios, the numbers understate the severity of the problem, “We actually think it’s pretty conservative,” he explained. “We’re only looking at people age 20 to 40. We know there’s a big chunk of households over age 40 who have student debt, too.”

Why student debt is a problem for everyone

A basic understanding of supply and demand is all that is necessary to understand the devastation to the housing market.

When people can’t buy homes because of their student loans, there is less demand for houses. Fewer buyers mean lower prices and more homes sitting on the market.

Going beyond simple supply and demand economics, the problem spirals out of control where a weakened housing market causes even more student debt according to researchers Gene Amromin of the Chicago Fed and Janice Eberly and John Mondragon of Northwestern University: “We find that as parents are unable to borrow against home equity, they push the burden of financing college enrollment onto students through student loans.”

In the United States, where consumer spending drives 70% of the GDP, student loan holders are poor consumers. For example, a $10,000 increase in student loans decreases the likelihood of homeownership in early adulthood by 5.7 percentage points and reduces the likelihood of having an auto loan by 6.5 percentage points.

Simply put, when a large portion of Americans are severely impacted by a financial hardship, everybody suffers the consequences.

How Student Debt Affects Individual Borrowers

Most borrowers view their student loan debt in terms of how much they cumulatively owe. In total Americans owe over $1.6 trillion on their student loans.

When it comes to buying a home, an individual’s total student loan balance isn’t the main issue. The number that most lenders care about is a mortgage applicant’s debt-to-income ratio or DTI. These calculations are based upon what a borrower is expected to pay each month on their loans.

Looking at student debt burdens from the monthly perspective like mortgage companies sheds some light on ways that more student loan borrowers can participate in the housing market. Obviously, student loan forgiveness plans would be a huge boost to both individuals and the housing market. However, smaller steps to help borrowers’ monthly balance sheets could also help.

If student loans had lower interest rates, monthly bills would be smaller and more borrowers could qualify for a mortgage. In fact, if the forgiveness proposals fail to become reality, there are still many steps the government could take to make life with student loans better.

The other big problem facing student loan borrowers is saving for a down payment. With high-interest student debt, leaving money in a savings account earning 1-2% makes little sense. Not having money for a down payment means many borrowers never even consider the possibility of buying a home.

The good news for borrowers is that there are a number of strategies that can be used to help make the dream of homeownership a reality.

Final Thoughts

Many Americans see student loans as someone else’s problem.

The reality is that student debt is a far-reaching drain on the economy. Addressing these issues may not be easy or cheap, but it is in the best interests of everyone.

The post How Student Loans are Dragging Down the Housing Market and Hurting Everyone appeared first on The Student Loan Sherpa.

Mortgage underwriters seemed to devise new and creative accounting methods to inflate my student loan payments so that I couldn’t qualify for a mortgage. After working with a couple of different mortgage companies, I finally found a lender that seemed to understand how income-driven repayment plans worked. I became one of the lucky student loan borrowers who were able to buy a house.

The following year when interest rates dropped, I attempted to refinance my mortgage. I reached out to two lenders who offered excellent rates. I was told my student debt wouldn’t be an issue. Later on, in the mortgage process, both lenders changed their tune. Underwriters decided that I had too much debt and was too much of a risk.

In the couple of years that have passed since my foray into homeownership, things have gotten better for prospective homebuyers who happen to have student loans. Mortgage heavyweights Fannie Mae and Freddie Mac changed how they treat income-driven repayment plan payments for purposes of calculating the debt-to-income ratio. Under the new rules, I’ve been able to refinance.

The changes to underwriting standards give student loan borrowers a better shot at getting a loan or refinancing a loan, but it requires a bit of planning.

Getting a Mortgage vs. Refinancing

Before jumping into the specific strategy behind the mortgage refinance process, it is important to take a look at a couple of key differences between getting that first mortgage and refinancing the home loan.

When qualifying for a mortgage, homebuyers will usually work with a local lender that has a good reputation for closing on time and following through on their promises. Reputable local banks and mortgage brokers may not always offer the best interest rates, but the security provided makes them a smart choice. The timing of a home purchase is typically driven by personal factors such as job status, down payment savings, and geographic stability. Market interest rates might get some minimal consideration, but the decision to buy usually is driven by other factors.

When it comes to refinancing a home, interest rates are king. Potential borrowers what to know who has the best rates and who can close the cheapest. Working with a reputable local bank becomes less critical, and finding the best deal is the priority. If a refinance falls through at the last minute, the homeowner doesn’t lose out on their home. They just have to move on to a different lender.

Spend a few minutes on Zillow, and it will become clear that the companies offering the lowest mortgage rates are not the traditional home loan lenders. Instead, they are specialists focused on refinancing as many homes as possible with minimum time spent on any individual deal.

Getting Student Loans Ready for a Mortgage Refinance

In the world of home loan refinancing, speed and efficiency are critical to the high volume refinance companies.

With this in mind, it is important to have your ducks in a row on the student loan front. For borrowers with federal student loans, this means already being enrolled in the preferred repayment plan for a couple of months. Prior enrollment is essential because you want your credit report to be showing an accurate monthly payment.

Like the strategy for qualifying for a first home loan, borrowers should look to lock in the lowest possible monthly payment. For many, this means an income-driven repayment plan. Lenders will now accept very small monthly payments for underwriting purposes, even if the borrower has very large loan balances.

The exception is that a $0 payment can be a potential hurdle. This is because a $0 payment may look like a deferment or a forbearance. Some lenders will assume the monthly payment is 1% of the total student loan rather than accept a $0 per month payment.

The idea is to have a credit report that shows a federal student loan borrower with a simple, easy-to-manage monthly payment on their student loans. (Borrowers with private loans may want to refinance on a 20-year loan to lower monthly payments as well.)

Once the credit report is showing the smallest monthly payments possible, a borrower can start the refinance process.

Starting the Home Refinance Process

Like refinancing student loans, the key to refinancing a home loan is to shop around.

Rates often change throughout the day, so it can be tricky to find the best option. One tool that helps is following the 10-year treasury bond. Mortgage rates will generally move up and down with the 10-year treasury bond yield. Most financial sites make tracking the 10-year bond pretty easy.

When the 10-year bond dips, it is time to investigate rates with different lenders.

When I speak with a mortgage company, the first question I always ask is related to my six figures of student debt. The mortgage lenders should have a pretty good understanding of their underwriting process. The lenders that are picky about student debt should be upfront about their approach because they don’t want to waste their own time or yours.

Once the discussion regarding student loans has been covered, the debt shouldn’t be an issue going forward.

Final Tip

The mortgage companies are starting to get a better understanding of student debt, but they are not experts. Don’t expect a lender or broker to understand the differences in income-driven repayment plans or how they work.

With most lenders, if the credit report shows a manageable monthly payment, they will be satisfied. If an extra explanation is required, things will quickly become difficult.

The post Refinancing a Mortgage for Student Loan Borrowers appeared first on The Student Loan Sherpa.

Each one of these goals is a huge challenge. Meeting all three goals is even more difficult.

Hitting these milestones is complicated by the fact that starting early is important for each goal.

• The sooner student loans are paid off, the less money that is spent on interest.
• Early retirement contributions are important for growth and a comfortable retirement.
• Buying the right home at the right time can save a small fortune in rent and be the realization of a dream.

Factors like taxes, law changes, and different personal goals can greatly influence the strategy. There is no simple order of priorities.

The good news is that it is possible to balance these three goals. Today we will look at strategies to maximize retirement, accelerate student loan repayment, and buy a home.

Before Getting Started: Make Ends Meet

Put simply, if monthly spending exceeds monthly income, all three major goals are a long shot.

Going one step further, the more cash that can be freed up each month, the better.

Careful budgeting can shed a light on opportunities for saving. Many claim that they are only spending money on the essentials, but by taking a look at monthly spending, they may realize that there are some costs that can be cut or reduced.

Once the monthly budget is under control, student loan borrowers can shift their focus towards long-term goals.

Student Debt Elimination Strategy

There isn’t a simple rule of thumb for paying off student loans, because there are so many differences between the loans.

For some borrowers, chasing after student loan forgiveness will be the best opportunity to get rid of the debt.

Others may have loans with high interest rates, sometimes over 10%. Repayment of these loans is a much more urgent issue. Borrowers with high-interest student debt should either be aggressively paying off the loans or finding ways to get a lower interest rate.

The low-interest student loans are much less of a priority. Some borrowers have loans with interest rates at 3% or below. The fortunate borrowers in this category will usually benefit from paying the minimum. This allows additional funds to be used for goals like saving for a house or retirement.

Many borrowers will have interest rates that don’t fall into an obvious category. These borrowers will have to compare their student loan options with other opportunities.

Retirement Planning with Student Debt

Saving for retirement can seem overwhelming and complicated.

This site has already taken a detailed look at retirement plans and strategies for student loan borrowers.

A couple of important takeaways for planning purposes are the following:

• Employer matches are an excellent opportunity. Employees will almost always want to maximize this benefit. Employer matching provides instant balance growth, and there is no way to go back in time to catch up on lost matching contributions.
• Student loans with interest rates greater than 10% next need to be eliminated. Most investors can’t reasonably expect a return on their investments of more than 10%. Paying down high-interest student loans is like a guaranteed return on that investment.

Deciding between paying extra towards a student loan or saving for retirement can often come down to interest rates. If the investment is expected to earn 6% per year and the student loan charges 4% interest per year, the borrower is coming out ahead by 2% by investing. When the numbers are flipped, borrowers are better off paying down their debt.

Special Tip for Federal Loan Forgiveness Borrowers: Those working towards federal student loan forgiveness can get a double benefit by putting money in certain tax-advantaged retirement accounts like a 401(k) or IRA. These contributions not only build retirement savings, but the money set aside will lower the borrower’s AGI, which means lower payments on income-driven repayment plans like IBR, PAYE, and REPAYE.

Projecting the expected return on retirement contributions is far from an exact science. In some years the stock market does really well and can grow by more than 20%. In other years it can lose significantly. For planning purposes, savers can usually expect to earn 5-8% on average, but that will depend upon the investments selected.

Student loan borrowers looking to save for retirement will have to balance a number of factors that go beyond the math.

• What is your appetite for risk? Investing in the stock market can be risky, but it also provides opportunities for growth.
• Are you debt averse? Some people hate having any debt to their name, even if it means missing out on retirement opportunities, they want the debt eliminated first.

Generally speaking, high-interest student debt planning is easy because it just needs to be paid off right away. The low-interest debt is likewise easy because the money can be put to more productive use elsewhere. The interest rates in the middle range are where things get tricky, and judgment calls need to be made.

The important thing is the mindset. The goal isn’t to simply pay off all student debt as soon as possible. The goal isn’t to hit a retirement balance as soon as possible. The goal is to build wealth. Building wealth while eliminating student debt isn’t easy, but it can be done.

Buying a Home/Paying off a Mortgage

Purchasing a home is the largest purchase that most people make and is often a 30-year commitment. In addition to all of the work that goes into deciding when to buy and finding the right home, financial planning can be quite daunting.

There are two important home purchase phases for student loan borrowers trying to balance student loans, retirement and buying a house.

Phase 1: Getting the Mortgage
Phase 2: Paying off the Mortgage

Qualifying for a Mortgage with Student Loans

Student loan debt makes qualifying for a mortgage more difficult. It also makes saving for a down payment a challenge.

We’ve previously taken a close look at ways to manipulate student debt to help qualify for a mortgage, so today, we will get into the strategy behind saving for a down payment.

Traditionally, homebuyers needed to set aside 20% for a down payment. However, many lenders will now accept 5% down, or in some cases, even less. The downside for buyers with a smaller down payment is that they will have to borrow more, which means higher monthly payments. They will also likely have to deal with PMI (Private Mortgage Insurance).

Setting aside any down payment can be a challenge with larger student debt balances. The problem with saving for a down payment is that the highest interest savings accounts normally max out at around 2%. This means that money will probably go a little further when applied to a student loan balance or set aside for retirement due to the higher interest rates involved.

As a result, prospective homebuyers need to balance their need for a down payment against opportunities to eliminate debt or save for retirement. One possible workaround is borrowing money from a 401(k) or taking a first-time homebuyer IRA withdrawal. Dipping into retirement accounts early is always a risk, but it is one that some are willing to make.

Here again, there is no single right or wrong answer. The key is to look at a few different scenarios. Weighing the pros and cons of each option may shed light on the most desirable approach.

Paying Down the Mortgage or Student Loans

For student loan borrowers with a mortgage, it may be tempting to try to get the house paid off early.

Most financial experts will argue that with mortgage rates currently very low, it makes more sense to set the money aside for retirement rather than paying the house off early. However, there is a certain peace of mind that comes with a house being paid off, so many borrowers make it a priority.

With student loan interest rates normally much higher than mortgage rates, it typically makes more sense to pay off the student loans first. One notable exception would be for borrowers who are working towards student loan forgiveness.

Taxes can also shift the numbers. Mortgage interest is deductible, but it is only for people that itemize, and many couples will not benefit due to the recently raised standard deduction. Student loan interest is a much smaller deduction. However, because it is “above-the-line” it won’t matter whether the borrower itemizes or not. Be sure to understand the tax strategy for student loan borrowers and consult a tax expert when weighing paying down student debt against paying down a mortgage.

Final Thoughts

Eliminating student loans, buying a house, and saving for retirement are all important financial goals. Starting early is a critical component for each goal.

Student loan borrowers may have to make some tough decisions, but by understanding how these different goals interact, borrowers can put together an ideal plan that fits their individual needs.

The post Retirement vs. Student Loans vs. Mortgage: Which Comes First? appeared first on The Student Loan Sherpa.