Approximately 44 million people in the United States have student loans worth a total of $1.44 trillion, according to Experian. Many of these borrowers also own homes. While one of these debts can be difficult enough for a recent college graduate to handle, paying off both at the same time may appear to be an insurmountable challenge.
The most common approach to this problem is to make the minimum payments on one debt while making additional payments on the other to pay it off as quickly as possible. Other strategies involve making aggressive payments on both at the same time. Developing a specific plan for paying off both student loan and mortgage debt requires careful analysis of many financial factors.
Your ability to handle debt
Your debt-to-income (DTI) ratio is one of the most important values for determining your ability to handle your current debts. It's essentially the portion of your income that you're using to pay off debt, which can be calculated by dividing the payments you make toward debts each month by your total monthly income. This figure is typically expressed as a percentage by multiplying it by 100.
DTI is used by lenders to determine your creditworthiness, your ability to repay a loan. Two specific types of DTI exist, front-end and back-end DTI. Front-end DTI considers only housing debt, principally payments for mortgage and mortgage insurance. Back-end DTI takes into account all debts, including student loans, which can have a significant effect on this key indicator of creditworthiness.
Assume for this example that your mortgage payment is $1.8K per month and your gross income is $5K per month. Your front-end DTI is 36% (($1,800/$5,000) X 100), which is the maximum DTI that private mortgage lenders typically accept. However, you also have a student loan on which you pay $500 a month. The back-end DTI of 46% (($2,300/$5,000) X 100) would likely shut you out of the private lending market and disqualify you from most federal housing loans as well.
Qualifying for a mortgage
Your DTI will often be too high for you to qualify for a loan because of your student loan. One study has found that half the people with student loans had a back-end DTI of at least 49%, which is above the maximum sought by private lenders. To qualify for a mortgage in this case, you'll need to either pay down your student loan to get a qualifying DTI or save up for a sufficiently large down payment.
Ideally, you want to pay off your loan first before taking on the new debt of a mortgage. This is particularly true if you have no housing costs because you’re living with your parents or have some other similar living arrangement. However, if you’re currently paying rent but can afford to put some savings toward a down payment on a home, you might be better off taking that route.
Paying off two loans at once
Assuming that your student loan has not held you back from qualifying for a mortgage, now you are faced with the task of paying off both at the same time.
Create a bare-bones budget to determine what your maximum savings rate will be. Eliminate any discretionary spending, especially entertainment. That means no cable TV, eating out or even shopping for clothing you don’t need. Ensure you include your mandatory expenses such as housing, groceries, utilities and your student loan. Subtract this total from your take-home pay to determine what you would theoretically be able to save each month barring any emergencies.
One other expense you may want to consider is making more than the minimum payment on high-interest debt, such as a credit card. This is often a good move because the interest rate on a credit card is typically much higher than that of either a student loan or a mortgage loan. It may also help to arrange to have your desired savings automatically diverted into a separate account so you won’t be as tempted to spend it on something else.
Refinancing may be your best option if you already have both a student loan and a mortgage payment that you’re having trouble paying. This solution is particularly likely to benefit you if you took out one of these loans during a period of high interest rates. As of February 2020, interest rates are fairly close to their historic lows, meaning that you may be able to realize a significant savings by refinancing either your student loan or mortgage.
If you have a federal student loan, you can typically get a much lower interest rate by refinancing through a private lender. However, you will give up some flexibility on payments, so you need a greater degree of confidence that you can make the payments. The interest rate for Figure's student refinance loan⁵ starts at annual percentage rate (APR) of 4.25%2. This APR includes a discount of 0.25 percentage points and requires the applicant to have a credit score of at least 800, with more than $5,500 in discretionary income per month. This rate also requires a maximum term of five years.
Figure's mortgage refinance is a cash-out refinancing, meaning the new mortgage may be for a greater amount than the balance on your current mortgage6. Such a refinance can be employed as a strategy to pay off a student loan, because you would receive the difference between your new mortgage and your old mortgage in cash. If the interest rate on your mortgage refinance is less than that of your student loan, it might make sense to use the funds from the refinance to pay off the student loan.
The most important thing to remember about paying off multiple debts at once is that you shouldn’t get discouraged. Millions of your peers are in the same boat. Through hard work, perseverance and careful planning, others have paid off their loans and emerged debt-free. You can do it too.