By Joseph Reinke, CFA Founder of FitBUX
One of the goals we most often hear on our free FitBUX Coaching calls for student loans is the desire to purchase a home in the future. The question from many of our FitBUX Members is: Do I refinance my student loans now or do I purchase the home first then refinance my student loans?
This article addresses why that question arises, how to analyze it, and what we tend to recommend.
Refinancing Student Loans vs. Buying A House
We sometimes hear that it is “common knowledge” not do anything before buying a house because it may impact your creditworthiness and make you less likely to be approved for a mortgage. By anything I mean refinancing a student loan, consolidating credit card debt, getting an auto loan, etc…
The reasoning is every time you apply for a loan or try to refinance an existing loan, it is reported on your credit report as a hard inquiry. If you have too many hard inquiries in a short period of time, your credit score with drop.
While this may indeed happen, it is critical to look at your personal situation and understand 1) which route will save you the most money overall and 2) what is the likelihood of you not being able to secure a mortgage should you have a new hard inquiry on your credit report.
Analyzing The Question(s) And What Really Matters
First off, a single hard inquiry on your credit report will not do much harm to your credit score and if you have multiple hard inquiries, the effect will be muted over time.
As a general rule of thumb, if you’re not considering buying a home in the next 2 years, then the answer is easy: Look into refinancing your student loans now!
If you are looking to buy a house within the next 24 months, however, you’ll want to keep reading…
Before making a decision, it’s key to understand how each type of loan (mortgage vs. student loan refinancing) is underwritten, i.e. which variables and metrics lenders are looking at before deciding whether to extend you an offer.
The two key components to qualify is your debt-to-income (DTI) ratio and FICO Score. We will focus on the DTI ratio in this article.
How Your DTI Ratio Is Affected
Your DTI ratio is defined as the percentage of your gross monthly income used to repay the combined required payments on all your loans. For example, if the required payment on your student loan is $1,000 per month and you earn $5,000 per month gross, then your DTI ratio is 20%.
For context, the seven student loan companies FitBUX partners with will refinance your student loans if your DTI ratio is below 30% (one of our partners will go up to 40%).
For a mortgage, however, you can have a DTI ratio up to 40-45% sometimes higher depending on various factors. Thus, you can have a higher DTI ratio and still get a mortgage.
For example, assume you’re currently single, have a student loan payment of $1,000, and a monthly gross income of $5,000. Let’s say you get a mortgage and your monthly payment is $1,500. Thus, your combined required monthly payment for your student loan and mortgage is $2,500.
Your DTI ratio is now 50% and you will not qualify to refinance your student loans thus costing you money in the long run.
The Impact Of Your Marital Status
Often times we hear married couples say the above example does not apply to them because mortgage lenders consider dual gross incomes when making underwriting decisions.
For example, let’s now say that you make $5,000 per month and your spouse makes $5,000 per month, for mortgage qualification your income is $10,000. Thus, using the DTI ratio for mortgages above, you can have up to $4,500 in monthly debt payments.
When it comes to student loans, however, while you may be able to add a co-signer such as your spouse to improve your chances of getting approved, most lenders will only consider one (i.e. your) income regardless. Thus, if you have a $1,000 student loan payment, $4,500 mortgage ($5,500 overall monthly debt payment) and your own gross income is $5,000, your new DTI ratio for the purposes of student loan refinancing is 110%!
This is important because most student loan lenders, 6 out of 7 that FitBUX partners with, use this method to qualify married couples for student loan refinancing. Only one will proceed with the method similar to that of mortgages, i.e. they add both incomes instead of only using one to qualify you for the student loan refinance.
The “General” Recommendation
Of course, everyone’s situation is different and should be evaluated on an individual basis. However, in general, it is easier to refinance your student loans before you take on a mortgage. Therefore, you should refinance your student loans prior to obtaining a mortgage.
This general recommendation may change based on your situation. I have listed a few of those situations below:
- Buying a house saves you money vs. renting a house.
- Your parents are refinancing your student loans and the loans will no longer appear on your credit report.
- Your parents are co-signing either your student loans or home loan.
- Your credit score is barely qualifying you for a mortgage…i.e. the hard inquiry to refinance your student loans may drop your score slightly and prevent you from qualifying for a mortgage.