Can a Student Loan Refinance Make Homes More Affordable?
During the Great Recession, many Americans scaled back their use of most kinds of credit, but doubled down on education spending. Today, student debt is the largest category of household debt except for mortgages, and studies show that these higher debt levels are putting home ownership beyond the reach of many college grads.
For this group, a student loan refinance may be necessary before homeownership is possible.
Why is student loan refinancing so important? According to the Federal Reserve Bank of New York, "For those twenty-five-year-olds with student loans, student debt now comprises 69 percent of the debt side of their balance sheets. Given the increased popularity of student loans, some have questioned how taking on extensive debt early in life has affected young workers' post-schooling economic activity."
Student Loan Balances and Mortgage Approval
At this point there's a lot of student debt. The Federal Reserve says student debt totaled $509 billion in 2006, a balance which rose to $1.322 trillion by 2014. According to The Wall Street Journal, 2014 graduates will have more student debt then any prior class, an average of $33,000 per student for those with education loans.
How much debt students accrue is largely a by-product of where they go to school, their field of study and how many years it takes to earn a degree. Many people with college educations leave school with massive loan balances. The monthly payments required to reduce such debt limits the ability of borrowers to obtain credit for other purposes, including home mortgages and auto financing.
To understand why student loan payments are important, consider a couple in which both husband and wife are recent college graduates and earn $70,000 per year. Many lenders will allow them to devote as much as 43 percent of their monthly income to housing costs and other forms of recurring debt such as auto loans, credit card payments and student loans.
Their monthly income is $5,833 before taxes and 43 percent of this amount means they can allocate $2,508 for debts. If they have $500 in monthly student repayment costs, $600 a month for two car loans and $300 per month for credit card repayments, that leaves them $1,108 for mortgage interest, mortgage principal, property taxes and property insurance (PITI).
If they must pay $50 a month for property insurance and $200 a month for property taxes, they can then afford monthly mortgage payments of $858. At 3.75 percent for a 30-year fixed-rate loan, they can borrow as much as $185,266. However, unless they come up with 20 percent down, they'll probably have to pay for mortgage insurance. If they qualify for a community mortgage (eligibility is income-based, and in most parts of the country they would qualify), they put three percent down and finance the rest, and pay mortgage insurance premiums of .35 percent per year. That drops their loan amount to $177,567 for a $183,059 home with a $5,492 down payment.
If their required monthly payment for student debt was reduced to $300, our borrowers could afford a monthly payment for principal and interest of $1,058. With a 3.75 percent community mortgage they could borrow $218,958 and buy a $225,730 home with $6,772 down. In many communities, that's the difference between being able to afford a starter home and having to continue renting.
Student Debt Refinance
What can borrowers do to reduce monthly payments for student debt? Here are several baseline strategies.
Refinance — Just a like a home loan refinance, the idea is to obtain a lower rate, a smaller payment, or both. Private lenders may give preference — and lower rates — to graduates in particular specialties such as medicine and law.
Consolidate — It's not unusual to have a variety of student loans. Consolidation can provide the advantage of a single monthly payment, a longer term, a lower rate and smaller monthly payments. However, combining private and federal loans can result in the loss of federal loan protections, so judge the pros and cons of merging federal loans with the private variety.
Income-Driven Repayment Plans — Students with federal loans might want to consider three options: an Income-Based Repayment Plan (IBR Plan), a Pay as You Earn Repayment Plan or an Income-Contingent Repayment Plan (ICR Plan). The specifics vary, but in some cases the payment is limited to ten percent of your total monthly income.
Prepayments — Student loan programs can be prepaid without penalty. Tossing in extra money from a tax refund or holiday gift can help prune student debt and shorten the loan term. As the loan ages, the amount owed declines and it becomes easier to simply pay off the loan.
Deferments – Deferment means you are not required to make payments on your student loan. However, unless you have a federally-subsidized loan, interest will continue to accrue during the deferment period and your balance will increase. Deferment is generally available for graduate students, those in the military and the unemployed. Once the deferment ends, repayment resumes.
If you consider a student loan refinance, always make sure you obtain a clear benefit, such as a lower monthly payment, a lower interest rate or less debt. Ask about fees and charges and consider all the alternatives available to you.