How much house can a student borrower qualify for?
This answer depends on the maturity of the student loan.
Situation:
Consider a person with a $100,000 student debt.
- The person can either pay the debt back over a 10-year period or a 20-year period.
- The student loan is this person’s only consumer debt.
- The person earns $80,000 per year.
- The student loan interest rate is 7.0 percent.
- The mortgage interest rate is 4.0 percent.
- The mortgage term is 30 years.
Questions:
- How much mortgage can the person qualify for if the person keeps the student loan at 10 years?
- How much mortgage can the person qualify for if the person changes the student loan term to 20 years?
- What is the increased cost of the student loan payments involved by switching from a 10-year to 20-year student loan?
Answer: I developed a spreadsheet that calculates the maximum allowable mortgage this person can qualify for.
In order to qualify for a mortgage two conditions must hold.
- Monthly mortgage payments must be less than 28% of income.
- Monthly mortgage and consumer loan payments must be less than 38% of income.
The procedure used to calculate the allowable mortgage is as follows:
- First, I calculate the maximum allowable mortgage payment based on zero consumer debt. This value is 28 percent of monthly income.
- Second, I calculate the maximum allowable mortgage payment consistent with mortgage payments and consumer debt payments equal to 38 percent of income. This is done by backing out the student loan and allocating the rest to mortgage debt.
- Third, I insert mortgage interest rate, term and payment info into the PV functions to get the mortgage amount
- Fourth, The allowable mortgage is the minimum of the mortgage totals consistent with the two constraints.
The calculations for the two situations presented in this problem are presented in the table below
| Mortgage Qualification Example for Borrower with Student Debt | ||||
| row # | Student Loan Information | Note | ||
| 1 | Student loan Amount | $100,000 | $100,000 | Assumption |
| 2 | Interest Rate | 0.07 | 0.07 | Assumption |
| 3 | Number of Payments | 120 | 240 | Assumption |
| 4 | Student Loan Payment | $1,161 | $775 | From PMT Function |
| Mortgage Information | ||||
| 5 | Rate | 0.035 | 0.035 | |
| 6 | Term | 360 | 360 | |
| Income Assumption | ||||
| 7 | Income | $80,000 | $80,000 | Assumption |
| 8 | Constraint One: Maximum monthly mortgage payment consistent with this income assumption | $1,867 | $1,867 | 28% of monthly income |
| 9 | Constraint Two: Maximum monthly consumer and mortgage payments consistent with income | $2,533 | $2,533 | 38% of monthly income |
| 10 | Maximum mortgage consistent with constraint one. | $415,697 | $415,697 | pv of mortgage rate number of periods, and pmt where mortgage rate and payments are assumptions baed on the market and product chosen and payment is max allowable given income |
| 11 | Allowable mortgage payment consistent with constraint two given required student debt | $1,372 | $1,758 | Row 9 minus Row 7 |
| 12 | Max mortgage consistent with borrowing contraint two. | $305,593 | $391,505 | Use PV function with rate and term set by market and product and payment the amount of mortgage payment after required consumer payments |
| 13 | Allowable mortgage debt | $305,593 | $391,505 | Minimum of Row 10 and Row 12 |
An increase in the term of the student loan from 10 to 20 years increases the size of a mortgage a household can qualify for from $305,000 to $391,000.
Getting the extra mortgage is not cheap. The increased student loan term causes total student loan payments to go from $139.000 to $186,000.
Concluding thoughts: Most people who have $100,000 in student debt will have to refinance the student loan if they are going to buy a house.