Indebted young professionals seek modest home.
April 22, 2013 2:59 PM Subscribe
Will my student loans prevent us from getting a mortgage (even if the student loan debt will be forgiven in a few years)?
My spouse and I are looking at buying a home in the 225k- 250k range. We have 40k in liquid assets we're willing to put into a down payment without touching retirement accounts. We both have excellent credit. Given current interest rates, we estimate that would leave us with monthly payments from about 1400 to 2000, including property taxes, pmi, and homeowner's insurance. (Yes, our property taxes are atrocious). Our current home is about 1200 a month, so we are looking at a 200 to 800 increase in housing expenses.
We purchased our current home in 2009 at rock bottom price. We would want to sell our current home before we closed on a new home, but I'm putting that complication aside for the moment (We also think we could conservatively net 10k from the sale taking into account the criminally low price we paid, and the work we've put into it -- brand new kitchen and bathroom. But I'm not counting on those $$ given the variables in the housing market).
The real question is our debt to income ratio and whether we can reasonably expect a bank to loan us enough for a house at that price -- even though we know we can afford it. From what I understand, the key numbers for conventional loans are 28/36. The front end isn't a problem, but the back end could be. 36% of our monthly gross is about 3k. We have credit cards, but we pay them off every month, so that shouldn't be a factor. We both have car loans (total: 500 a month). The big thing is my minimum student loan payment, which is at least 1500 a month.
But here's the thing -- given the kind of job I have, I actually receive about 10k in student loan assistance each year from the university where I went to grad school. In other words, I pay about 667 in student loan payments per month out of my income, and 833 is paid with money from my school. But the 10k I receive in loan assistance isn't income. Technically, it's a loan, which will become due if I leave my job in less than 5 years. (I'm already 2 years in. I won't leave my job in less than 3 years voluntarily or otherwise. Accept this as true). When I fulfill my job commitment, the loan assistance from the university will be forgiven, at which point the entire amount of loan assistance will become (nontaxable) reportable income to me. And, at the conclusion of the five year term, all of my student loans will be paid. Yay! (This is why it makes no sense for me to use the 40k towards paying off my loans. It would be forfeiting thousands of $$). In the meantime, it's not income -- it's another debt!
I don't want to wait another two or three years to buy a house. There are some great bargains to be had in our area, and we've definitely outgrown our current home. I know we can afford this. How should I explain this to a bank or credit union? Is there a way for them to factor this loan assistance into the equation? Will a letter from my university explaining the program do the trick? Basically, I have no idea how to begin to convey my financial situation to a lender. On paper, my loans looks like a bad bet. In reality, this is the perfect time for us to buy. Help!
My spouse and I are looking at buying a home in the 225k- 250k range. We have 40k in liquid assets we're willing to put into a down payment without touching retirement accounts. We both have excellent credit. Given current interest rates, we estimate that would leave us with monthly payments from about 1400 to 2000, including property taxes, pmi, and homeowner's insurance. (Yes, our property taxes are atrocious). Our current home is about 1200 a month, so we are looking at a 200 to 800 increase in housing expenses.
We purchased our current home in 2009 at rock bottom price. We would want to sell our current home before we closed on a new home, but I'm putting that complication aside for the moment (We also think we could conservatively net 10k from the sale taking into account the criminally low price we paid, and the work we've put into it -- brand new kitchen and bathroom. But I'm not counting on those $$ given the variables in the housing market).
The real question is our debt to income ratio and whether we can reasonably expect a bank to loan us enough for a house at that price -- even though we know we can afford it. From what I understand, the key numbers for conventional loans are 28/36. The front end isn't a problem, but the back end could be. 36% of our monthly gross is about 3k. We have credit cards, but we pay them off every month, so that shouldn't be a factor. We both have car loans (total: 500 a month). The big thing is my minimum student loan payment, which is at least 1500 a month.
But here's the thing -- given the kind of job I have, I actually receive about 10k in student loan assistance each year from the university where I went to grad school. In other words, I pay about 667 in student loan payments per month out of my income, and 833 is paid with money from my school. But the 10k I receive in loan assistance isn't income. Technically, it's a loan, which will become due if I leave my job in less than 5 years. (I'm already 2 years in. I won't leave my job in less than 3 years voluntarily or otherwise. Accept this as true). When I fulfill my job commitment, the loan assistance from the university will be forgiven, at which point the entire amount of loan assistance will become (nontaxable) reportable income to me. And, at the conclusion of the five year term, all of my student loans will be paid. Yay! (This is why it makes no sense for me to use the 40k towards paying off my loans. It would be forfeiting thousands of $$). In the meantime, it's not income -- it's another debt!
I don't want to wait another two or three years to buy a house. There are some great bargains to be had in our area, and we've definitely outgrown our current home. I know we can afford this. How should I explain this to a bank or credit union? Is there a way for them to factor this loan assistance into the equation? Will a letter from my university explaining the program do the trick? Basically, I have no idea how to begin to convey my financial situation to a lender. On paper, my loans looks like a bad bet. In reality, this is the perfect time for us to buy. Help!
I'm already 2 years in. I won't leave my job in less than 3 years voluntarily or otherwise. Accept this as true
I'll accept it as true, but I'm not being asked to lend you $200,000. If I were, I would absolutely count the entire $1500 as debt.
You should pull your credit scores yourselves (so that the pull doesn't count against you as an inquiry) and go in to talk to a lender. They will be able to give you a good idea of what they can do, without your having to officially apply at this stage.
Please don't end the inquiry there, though. Figure out what you really and truly can afford regardless of what the bank will lend you. Some experts including Senator Elizabeth Warren recommend keeping your required expenses - rent, utilities, car, car insurance, debt, groceries, gas, cell phones, clothing - under half of your net income. You are pushing up against that number even now, and to add $200-800 in housing expenses (not counting maintenance, which adds up fast) could mean sacrificing your retirement savings or other goals, like travel. Ask me how I know!
posted by payoto at 3:30 PM on April 22, 2013
I'll accept it as true, but I'm not being asked to lend you $200,000. If I were, I would absolutely count the entire $1500 as debt.
You should pull your credit scores yourselves (so that the pull doesn't count against you as an inquiry) and go in to talk to a lender. They will be able to give you a good idea of what they can do, without your having to officially apply at this stage.
Please don't end the inquiry there, though. Figure out what you really and truly can afford regardless of what the bank will lend you. Some experts including Senator Elizabeth Warren recommend keeping your required expenses - rent, utilities, car, car insurance, debt, groceries, gas, cell phones, clothing - under half of your net income. You are pushing up against that number even now, and to add $200-800 in housing expenses (not counting maintenance, which adds up fast) could mean sacrificing your retirement savings or other goals, like travel. Ask me how I know!
posted by payoto at 3:30 PM on April 22, 2013
If I have the math right, if 3K is 36% of your income, you gross about $8333 per month. You say you are sure you could afford a higher house payment ("we know we can afford it"), but I am not so certain. I think you are playing with the numbers to get them to support your position.
Let's look at the actual gross income you are receiving and the total debts you are paying, and figure out the percentages.
So, you gross $8333 per month. You also get an additional $10K per year of untaxed income, right? That brings your total monthly gross income up to $9166. With me so far?
You are looking at houses from $225K to $250K.
At the low end of the price range, assuming you are correct with your own calculations,, the house payment is $1400, without water and utilities added in (which will also increase with a larger house, remember).
You owe $2000 in debt a month. Remember, we have already added in that untaxed 10K in your income.
Total monthly debt: $3400. That's 37% of your income going into paying off loans.
At the $250K level, you would be paying $4000 a month ($2K current loan payments plus the $2K house payment).
That's 44% of your gross income a month going into paying off debts!
That seems...well, frankly, insane, to me. I sure wouldn't feel comfortable with it.
But I'm not you.
Either way, you are above that golden 36% metric.
Let's look at what the experts suggest you should do.
Now, you can go quite conservative, and take arguably the safest and smartest route, in which case you want to go for a 15 year mortgage rather than a 30 year mortgage, and keep your house payment under 25% of your take-home pay. That's the safest route for young house buyers to take to avoid further debt, foreclosure, etc., and it makes sound economic sense.
Very few people actually do that, of course. We don't want to wait to get a house! We don't want a "cheap" house paid off sooner, we want a "nice" house!
You could also go all out and get aggressive and spend 35% of your gross income on your house payment alone, which, believe it or not used to be the standard practice. Banks pre-qualified people for the biggest house they could possibly "afford". Yay! Now we can have a REALLY "nice" house as long as we keep the house payment under $3208!
Except banks don't do this much any more, because so many homeowners ended up in foreclosure under this formula. Once your car breaks down, your health goes downhill, your bills go up (for instance, when you have kids) or your work situation changes, suddenly you can't make those monthly house payments.
A good rule of thumb that young home buyers can live by, I think, is to take a reasonable middle route. That's where that 28/36 metric comes in, and it's a good one.
Keep your house payment under 28% of your gross monthly income, and your total debts under 36%.
28% of 9166 is 2566.48/mo. That would be higher than what you are looking at, as far as the housing goes. But you have that $2000 in monthly debt already, and you can't just get rid of that. You'd go way over that 36% of total income in debt every month.
So let's work backwards, then, with the $1500 in student loans and the $500 car payment each month taken out first. To keep the total debt under 36%, you can afford to pay 1299.76 on housing per month. That's pretty much what you are paying now, and it seems to be working out for you just fine.
But I know you want more house than you have now. Sure you don't want to just wait those three years? No?
If you want to go the aggressive route, the maximum debt the financial experts suggest, provided the banks will work with you to get there (a big IF), is 40% of your gross monthly income (This is known as the Rule of 40).
If we accept that 40% guideline (makes me want to pull my hair out, but you might be okay with it), you can take on a total house payment (including property taxes and insurance) of $1666.40/month.
No matter what the bank is willing to loan you, you really should not even consider going higher than that.
Frankly, I would just wait out those 3 years. I'd probably even go for a 15 year mortgage once those student debts are paid off. But you should go with your own comfort level here.
posted by misha at 7:52 PM on April 22, 2013 [3 favorites]
Let's look at the actual gross income you are receiving and the total debts you are paying, and figure out the percentages.
So, you gross $8333 per month. You also get an additional $10K per year of untaxed income, right? That brings your total monthly gross income up to $9166. With me so far?
You are looking at houses from $225K to $250K.
At the low end of the price range, assuming you are correct with your own calculations,, the house payment is $1400, without water and utilities added in (which will also increase with a larger house, remember).
You owe $2000 in debt a month. Remember, we have already added in that untaxed 10K in your income.
Total monthly debt: $3400. That's 37% of your income going into paying off loans.
At the $250K level, you would be paying $4000 a month ($2K current loan payments plus the $2K house payment).
That's 44% of your gross income a month going into paying off debts!
That seems...well, frankly, insane, to me. I sure wouldn't feel comfortable with it.
But I'm not you.
Either way, you are above that golden 36% metric.
Let's look at what the experts suggest you should do.
Now, you can go quite conservative, and take arguably the safest and smartest route, in which case you want to go for a 15 year mortgage rather than a 30 year mortgage, and keep your house payment under 25% of your take-home pay. That's the safest route for young house buyers to take to avoid further debt, foreclosure, etc., and it makes sound economic sense.
Very few people actually do that, of course. We don't want to wait to get a house! We don't want a "cheap" house paid off sooner, we want a "nice" house!
You could also go all out and get aggressive and spend 35% of your gross income on your house payment alone, which, believe it or not used to be the standard practice. Banks pre-qualified people for the biggest house they could possibly "afford". Yay! Now we can have a REALLY "nice" house as long as we keep the house payment under $3208!
Except banks don't do this much any more, because so many homeowners ended up in foreclosure under this formula. Once your car breaks down, your health goes downhill, your bills go up (for instance, when you have kids) or your work situation changes, suddenly you can't make those monthly house payments.
A good rule of thumb that young home buyers can live by, I think, is to take a reasonable middle route. That's where that 28/36 metric comes in, and it's a good one.
Keep your house payment under 28% of your gross monthly income, and your total debts under 36%.
28% of 9166 is 2566.48/mo. That would be higher than what you are looking at, as far as the housing goes. But you have that $2000 in monthly debt already, and you can't just get rid of that. You'd go way over that 36% of total income in debt every month.
So let's work backwards, then, with the $1500 in student loans and the $500 car payment each month taken out first. To keep the total debt under 36%, you can afford to pay 1299.76 on housing per month. That's pretty much what you are paying now, and it seems to be working out for you just fine.
But I know you want more house than you have now. Sure you don't want to just wait those three years? No?
If you want to go the aggressive route, the maximum debt the financial experts suggest, provided the banks will work with you to get there (a big IF), is 40% of your gross monthly income (This is known as the Rule of 40).
If we accept that 40% guideline (makes me want to pull my hair out, but you might be okay with it), you can take on a total house payment (including property taxes and insurance) of $1666.40/month.
No matter what the bank is willing to loan you, you really should not even consider going higher than that.
Frankly, I would just wait out those 3 years. I'd probably even go for a 15 year mortgage once those student debts are paid off. But you should go with your own comfort level here.
posted by misha at 7:52 PM on April 22, 2013 [3 favorites]
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The first mortgage broker didn't understand any of this and was ready to reject us, but the second one we talked to (on recommendation from a friend) was completely comfortable with the situation. We're going through FHA so circumstances might be different, but it couldn't hurt to try a few brokers before you give up.
posted by ella wren at 3:18 PM on April 22, 2013