Paying one loan with another loan is also referred to as debt reshuffling. Although it might feel good to have one less bill to pay, debt reshuffling is not magic. You still owe the money–you’ve just changed the terms and possibly forfeited protections you might need later, but we’ll get to that in a moment.
The reality is that with consolidation it feels like you’re making progress, says Chris Hogan, financial coach and author of Everyday Millionaires. You’re taking this big chunk of student loan debt and getting rid of it.
Really, though, you are attaching that debt to your home in place of equity. It’s a move that requires careful consideration.
The goal of the home is for you to own it. What you’re doing is taking the equity out of your home immediately by the size of the student loan debt.
1) High Debt-to-Income Ratio.
When lenders decide whether you qualify for a mortgage, they review how much of your monthly income is devoted to debt repayments, such as payments for:
- student loans
- credit card debt
The overall result is your debt-to-income ratio (DTI). This ratio further breaks down into:
- Front-end ratio: The percentage of your income consumed by mortgage expenses
- Back-end ratio: The percentage of your income consumed by all other debt
For the most part, lenders want potential homeowners to maintain a front-end ratio of no more than 28% and a back-end ratio no more than 36%.
For doctors and other high-income professionals, some lenders allow back-end ratios as high as 43%.
If your back-end DTI is roughly 30%+, it’s probably best to continue renting until you’ve paid down more debt.
Remember, as a doctor, lenders will tend to loan you more money. But just because you qualify for a loan doesn’t mean you should take one out.
2) YOU DON’T HAVE ENOUGH FOR A DOWN PAYMENT
A report from the National Association of Realtors revealed the typical home down payment is 6% or less for 60% of first-time home buyers.
Typically, if your down payment is less than 20%, then you’re required to pay private mortgage insurance (PMI). PMI can add 0.5 to 1% to your monthly mortgage payment.
If you purchase a home for $200,000, for example, then you could face an extra $83.32 to $166.64 each month in PMI.
WHAT ABOUT DOCTOR MORTGAGE LOANS?
The definition of a doctor mortgage loan is one that:
- Does not charge PMI despite having a down payment of less than 20%
- Will close with a signed employment contract rather than pay stubs
- Only considers the payments of student loans (not the entire loan burden)
- Is not an FHA or VA loan
As a general rule, the rates and fees on these loans will be slightly higher than what you can get with a 20% down conventional mortgage. That’s the price you pay for the convenience of not having to meet conventional mortgage rules and for being able to use your down payment money to:
- pay off student loans
- max out retirement accounts
The terms are highly variable and include:
- 30 year fixed
- 15 year fixed
- 5/1 ARMs
- 7/1 ARMs
- 10/1 ARMs
3) YOU WANT TO AVOID BEING HOUSE POOR
We rented for over ten years while I was in training. After purchasing our first home, I had no idea the amount of additional recurring and sometimes unexpected expenses that homeownership brought along with it.
Besides regular maintenance costs, you must factor in other repair expenses such as:
- leaky roof
- the furnace breaks
- when the A/C unit goes caput
- when the wife wants new furniture!
A good way to avoid this is to have a buffer in your budget to absorb these additional costs and consider purchasing a home that is less than the amount you’re qualified to buy.
4) BECAUSE DAVE SAYS SO
If you’re an avid follower of Dave Ramsey and you agree with the mortgage advice he gave to the caller in the video above, then, by all means, pay them off.
Looking back, our marriage would have had much less stress early on if we had done it this way.
3 REASONS TO BUY A HOME WHEN YOU STILL HAVE STUDENT LOAN DEBT
1) YOUR DEBT-TO-INCOME RATIO IS LESS THAN 28%
If your front-end ratio (the percentage of your income consumed by mortgage expenses) is significantly less than 28 percent, then you should be in good shape to:
Consider obtaining a mortgage while being able to pay back your student loans aggressively.
2) YOU’VE SAVED UP A LARGE DOWN PAYMENT
If you’ve been able to save up 20%+ for a down payment while accelerating your student loan payments, then you might be ready to take on a mortgage.
3) YOU HAVE A STUDENT LOAN WITH A LOW MONTHLY PAYMENT
If your student loan payments are a little too high for you to comfortably afford a mortgage, you may be able to refinance or consolidate your student loans, which means you could qualify for a lower monthly payment.
Even if you can get it lower, make sure you consider the other advice mentioned above before purchasing a home.
DAVE RAMSEY MORTGAGE ADVICE
If you’re going to buy a home with a mortgage, you need to have the basics covered.
Here’s what we recommends:
- You’re completely debt-free.
- You have three to six months of expenses saved in an emergency fund.
- You’ve saved at least 20% for a down payment to avoid PMI payments.
HOW MUCH HOUSE CAN I AFFORD?
Now that you’ve gotten a little Dave Ramsey mortgage advice, let’s take a look at how much house he recommends we can afford.
CALCULATE THE COSTS
If you’re married or soon to be, it’s important to get on the same page as your spouse. It’s extremely difficult to obtain financial freedom when one spouse isn’t on board with the other. Buying a home is no exception, it’s all about the numbers.
Here are the 4 steps Dave recommends when figuring on how much house you can afford.
1) ADD UP THE MONTHLY HOUSEHOLD INCOME
If you bring home $6,400 a month and your spouse makes $3,600 a month. Your total monthly take-home pay would be $10,000.
Don’t forget to add in any money from side-gigs too.
2) MULTIPLY YOUR MONTHLY TAKE-HOME PAY BY 25% TO GET YOUR MAXIMUM MORTGAGE PAYMENT.
If you earn $10,000 a month, that means your monthly house payment should be no more than $2,500.
His housing rule of thumb is quite different than the recommendations you’ll find elsewhere.
3) USE DAVE’S MORTGAGE CALCULATOR TO DETERMINE HOW MUCH HOUSE YOU CAN AFFORD.
Here’s what his calculator determines a person or family can afford with:
- Home price of $600,000
- Down payment of 10%
- 15-year fixed mortgage
- Interest rate = 4.25%
- Private mortgage insurance (PMI) of $225 a month
- Property tax = $6,600 a year
- $846 in homeowners insurance cost
Sticking with our example of the family with an income of $10,000 a month, they couldn’t afford the above house as their recommended monthly mortgage payment should be no more than $2500 a month.
In the above example of a mortgage payment of about $5,000, that would mean you’d need take-home pay of $20,000 per month.
Remember that when you obtain a mortgage pre-approval, lenders will likely approve you for a loan amount with payments larger due to your above average income.
That may tempt you to take on more home than you should. Don’t just assume that just because the bank approved it, you can afford it. They are two very different things.
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