Nov 12

Is it wise to have no debt at all when you are planning a mortgage in the not-too-distant future? That’s what I was pondering after a blogger I follow was considering wiping out her student loan.


If you’ve not read Stephanie’s blog, Graduated Learning, you might give it a try. The tag line is “I got my degree, I got a job…now what?” Not just any degree, Stephanie is an MIT graduate. Now, to her shared thought bubble above. Here’s what we know, she has a 2.75% student loan, enough cash to pay it off, and an engagement ring on her finger. No high interest debt, else that would surely be the priority for payment. Let’s look at how paying off the student loan might impact the size house she and her new hubby can buy.

We’ll make some assumptions, to offer a general idea of why you should or shouldn’t kill that last bit of debt before buying your first house. We’ll keep the math simple and start with a $100K salary. Engineering grads are starting higher than $50K, but $100K makes it easy for you to scale up or down to your our salary. When applying for a mortgage, the old ratios used to be 28/36. This means that monthly housing debt can be up to 28% of monthly income and total debt, 36%. In this example, 28% is $2333 per month. Let’s set aside $500 of this for property tax, and look at an $1833/mo mortgage payment. The 30 year fixed rate is just under 4.25% right now, so my trusty TI35 calculator tells me the new couple can afford a $372,600 mortgage. With 20% down, this is a house purchase of $465,750, and the down payment is $93,150. For most people, it’s not the mortgage that’s the deal breaker, it’s the down payment. The money she might wish to use to pay off the student loan will be very precious when she and Mr Blogger are house hunting.

Paying off the debt won’t put them in a better position, either. You recall that I mentioned that total debt service can be 36%? That 8% gap from 28 to 36 is $667/mo. Enough to support payment on a 10 year student loan of nearly $70K. You see how this works? The payment toward the loan isn’t impacting their ability to get a mortgage, and paying it off wont enable them to get a higher mortgage. But the ability to put 20% is pretty important. Imagine finding the right house, all is perfect, location, size, price, etc. But having paid off that student loan, they are a bit short on the down payment, and need to wait 6 months to save up again. Better to pay the 2.75% loan’s minimum payments, and in a year or two, after they are settled in the house, see if the emergency fund is topped off. And the retirement accounts are funded at least to the match. After that, if they wish to get rid of that low interest debt, no problem.

Last – the area we live in, not far from Boston, isn’t near the US average. Home prices can easily exceed $500K without living in a McMansion. And living too far from one’s job can result in 3 hours of daily commuting time. But again, these numbers are just an example to illustrate the need for that down payment and how the 28/36% gap can work to your benefit.


written by Joe \\ tags: ,

Mar 31

A Guest Post –

After graduation, most loan companies give you a six-month grace period and then expect you to start paying back your loan. The repayment plan is usually set to a ten-year schedule. If you have the money to pay the loans back, this is generally the best way to avoid high interest rates and pay down your principal. Most struggle with this type of repayment plan. Fortunately, there are ways to alleviate your monthly student loan burden. The first thing you will want to consider is loan consolidation. Consolidation allows you to pay one amount each month instead of sending payments to several different loan companies. It also gives you the option of lengthening your repayment schedule so you can pay back less money each month. Be aware that you will inevitably pay back more interest over the life of the loan using this method. Several different loan repayment options are now available.

The government offers an income based and income sensitive repayment option for those with federal loan debt. These plans calculate the amount you owe based on your monthly income and number of dependents. It is not uncommon for some to have a monthly payment liability of zero while on these plans. In addition, loan holders who work for a government or nonprofit agency may qualify for loan forgiveness after 120 consecutive monthly payments. Finally, there are other more drastic options out there for those who qualify. Deferments allow those who are unemployed, in school, or under a financial hardship to postpone payments for up to six months at a time. Remember that defaulting on your student loans will only mean trouble down the road. Even bankruptcy won’t allow you to get out of this responsibility. Before you default, call your loan company. They are usually willing to work with you on a repayment plan.

written by Joe \\ tags: ,