Student debt and qualifying for a mortgage
Excel Topics: PMT function and Spreadsheet design
Question: A person graduates from college and graduate school with $100,000 in student debt. The interest rate on a 10-year student loan is 5% per year. The person wants to buy a house that costs $300,000 with a 90% LTV loan. The home mortgage interest rate is 4.5% on a 30 year FRM.
Assume that in order to qualify for the house the person must meet two conditions.
Constraint One: The ratio of mortgage interest to income must be less than 0.28.
Constraint Two: The ratio of total interest (mortgage and non-mortgage) interest must be less than 0.38.
How much income does this person need to qualify for a loan on this house?
Why might student debt have a smaller impact on the purchase of a $700,000 home than the purchase of a $300,000 home.
Analysis: The analysis for the $300,000 home is laid out in the table below.
|Mortgage Qualification Example for Borrower with Student Debt|
|Student loan Amount||$100,000||$0||Assumption|
|Number of Payments||120||120||Assumption|
|Student Loan Payment||$1,061||$0||From PMT Function|
|Loan Amount||$270,000||$270,000||LTV * House Amount|
|Number of Payments||360||360||Assumption|
|Mortgage Payment||$1,368||$1,368||From PMT Function|
|Total Loan Payments||$2,429||$1,368||Sum Payments|
|Monthly Income Constraint One||$4,886||$4,886||Student Loan Payment divided by 0.28|
|Monthly Income Constraint Two||$6,391||$3,600||Mortgate Payment Divided by 0.38|
|Required Monthly Income||$6,391||$4,886||Max of income over both constraints|
|Required Annual Income||$76,696||$58,631||12* Max Income|
Observations Pertaining to the $300,000 home for a person with and without student loans
A person with no student debt could qualify for this mortgage with an annual income of $58,630.
The person with the student debt needs an annual income of $71,585.
The impact of student debt on purchases of a larger home: The allowable mortgage is determined by two constraints one involving mortgage debt only and the other involving the sum of mortgage and consumer debt. When the mortgage debt is very large, constraint one (the mortgage debt constraint) will be the binding constraint.
Download the student debt and mortgage qualification spreadsheet by clicking below:
This spread sheet can be modified to consider how different types of debt like consumer loans impact the mortgage qualification decision. Also, some banks allows borrowers to hold more total debt or more mortgage debt. The parameters defining the permissible amount of lending can be modified to reflect these differences.