OT: Paying off student loans...credit impact / hurting my ability to get a mortgage?

[4Rings6Stars]

You fine folks have never steered me wrong. You might remember a thread from a few months ago where I asked about buying a fixer upper or a move in ready house... along that same vein, I have a question about personal finances.

First question:
You guys are great...but who should I be going to to talk about this stuff? Family type financial advisor? I have it in my head that these people will just try to sell me insurance I don't need and convince me to invest in funds that benefit them.

My scenario:

Between my wife and I we have a decent amount of student loans dating back to 2008-2013. Rates are between 4.5% and 6.6%. Since I started working in early 2013, we have been frugal and have saved a good amount towards a down payment.

I have a few times wondered if I should pay off the student loans first but have talked myself out of it as I didn't want to lose the ability to buy a house if the right place came along. It's constantly nagging at me though as we essentially have enough cash in the bank to pay off the loans. A few months ago, I decided to pay off a few of the higher rate loans (total of about 10k). It felt great. I convinced myself that I would pay off all / most of the loans and that I would still be able to get a decent mortgage even without a 20% payment and that PMI would be less than I was paying in interest on my loans. Before I could do so, my credit monitoring app alerted me that my score had dropped 18 points! I investigated and found that it was most likely caused by the impact paying off the loans had on my "age of credit history" as nothing else had changed, no late payments, etc.

Seems crazy that paying off these loans will hurt my credit score and my ability to get a new loan...but I guess that's how the formulas work.

Any insight on this? I'm now thinking it's best to just sit on the cash until I'm ready to buy a house and then pay off the loans as fast as I can once I have the mortgage. I have never had a car loan or anything, so besides credit cards, the student loans are really my only credit history. Another 18 point drop to my score would not be good!

[nicrump]

im likely to get smacked down by the "experts" here but truth is the system is rigged to keep you paying interest. don't fall for the system. don't carry debt other than a mortgage IMO. pay off those loans and build the saving back to a better than 20% down plus extra cause you will want to spend a pile of cash on all the new things you need in first time home ownership. another trap people fall into is running up CCs on all that new house stuff.

[54ny77]

it's not the loans in & of themselves that matter, it's your debt to income (dti) ratio once you get a mortgage.

assuming both you & wife will be on mortgage, add up all your combined monthly debt payments, which includes credit cards, student loans, car loans/lease, any other recurring monthly debt, and then the mortgage (which is principal, interest, taxes and insurance). then divide by your household gross monthly income (pre-tax).

if that number is greater than 36%, you need to pay off those debts that impact your dti ratio (or look for a higher paying job!).

a hypothetical example:
total monthly debt obligations: $2,800
total gross income: $5,150
math: $2,800 divided by $5,150 = 54% dti
that's bad.

in that scenario, you'd need to find ~$1,000 in recurring monthly savings to get down to 36% dti. while you can get loans up to 45% dti, that requires reserves and so forth, beyond the scope of this basic answer.

long story short, target your total monthly debt to be no more than 36% of your gross income. that way you'll have a better time qualifying for a mortgage.

that aside, if you have sufficient cash, pay off the student loans. by paying off, you're "earning" a rate of return equivalent to what you'd otherwise be paying on those loans, i.e., you no longer have the liability. there's tremendous psychological value to that.

Originally Posted by 4Rings6Stars

You fine folks have never steered me wrong. You might remember a thread from a few months ago where I asked about buying a fixer upper or a move in ready house... along that same vein, I have a question about personal finances.

First question:
You guys are great...but who should I be going to to talk about this stuff? Family type financial advisor? I have it in my head that these people will just try to sell me insurance I don't need and convince me to investment in funds that benefit them.

My scenario:

Between my wife and I we have a decent amount of student loans dating back to 2008-2013. Rates are between 4.5% and 6.6%. Since I started working in early 2013, we have been frugal and have saved a good amount towards a down payment.

I have a few times wondered if I should pay off the student loans first but have talked myself out of it as I didn't want to lose the ability to buy a house if the right place came along. It's constantly nagging at me though as we essentially have enough cash in the bank to pay off the loans. A few months ago, I decided to pay off a few of the higher rate loans (total of about 10k). It felt great. I convinced myself that I would pay off all / most of the loans and that I would still be able to get a decent mortgage even without a 20% payment and that PMI would be less than I was paying in interest on my loans. Before I could do so, my credit monitoring app alerted me that my score had dropped 18 points! I investigated and found that it was most likely caused by the impact paying off the loans had on my "age of credit history" as nothing else had changed, no late payments, etc.

Seems crazy that paying off these loans will hurt my credit score and my ability to get a new loan...but I guess that's how the formulas work.

Any insight on this? I'm now thinking it's best to just sit on the cash until I'm ready to buy a house and then pay off the loans as fast as I can once I have the mortgage. I have never had a car loan or anything, so besides credit cards, the student loans are really my only credit history. Another 18 point drop to my score would not be good!

[45K10]

Originally Posted by nicrump

im likely to get smacked down by the "experts" here but truth is the system is rigged to keep you paying interest. don't fall for the system. don't carry debt other than a mortgage IMO. pay off those loans and build the saving back to a better than 20% down plus extra cause you will need spend a pile of cash on all the new things you need in first time home ownership. another trap people fall into is running up CCs on all that new house stuff.

Agreed, I quit playing the borrowing money game about 10 years and haven't looked back. The wife and I have never had student loans, so I can't advise you on that, but we don't owe money on anything (car, etc.). We have a contract on a house right now, we are putting 20% down and have banks falling over us to give us a loan. My advice is to get rid of the debt then save enough for a 20% down payment and never ever borrow money again. I know that is easier said than done but it is possible even with kids.

Good luck!

[yngpunk]

Originally Posted by 4Rings6Stars

You fine folks have never steered me wrong. You might remember a thread from a few months ago where I asked about buying a fixer upper or a move in ready house... along that same vein, I have a question about personal finances.

First question:
You guys are great...but who should I be going to to talk about this stuff? Family type financial advisor? I have it in my head that these people will just try to sell me insurance I don't need and convince me to invest in funds that benefit them.

My scenario:

Between my wife and I we have a decent amount of student loans dating back to 2008-2013. Rates are between 4.5% and 6.6%. Since I started working in early 2013, we have been frugal and have saved a good amount towards a down payment.

I have a few times wondered if I should pay off the student loans first but have talked myself out of it as I didn't want to lose the ability to buy a house if the right place came along. It's constantly nagging at me though as we essentially have enough cash in the bank to pay off the loans. A few months ago, I decided to pay off a few of the higher rate loans (total of about 10k). It felt great. I convinced myself that I would pay off all / most of the loans and that I would still be able to get a decent mortgage even without a 20% payment and that PMI would be less than I was paying in interest on my loans. Before I could do so, my credit monitoring app alerted me that my score had dropped 18 points! I investigated and found that it was most likely caused by the impact paying off the loans had on my "age of credit history" as nothing else had changed, no late payments, etc.

Seems crazy that paying off these loans will hurt my credit score and my ability to get a new loan...but I guess that's how the formulas work.

Any insight on this? I'm now thinking it's best to just sit on the cash until I'm ready to buy a house and then pay off the loans as fast as I can once I have the mortgage. I have never had a car loan or anything, so besides credit cards, the student loans are really my only credit history. Another 18 point drop to my score would not be good!

A couple of thoughts...

1) Don't know your income level, but suspect that your student loan interest is deductible on your taxes, so might want to take that into consideration when debating to pay off the loan vs. investing the money

2) Have you looked into consolidating your loans into a single loan at a lower interest rate?

3) Depending on how good your credit is, I wouldn't worry about an 18 point drop in your credit score. Besides, any mortgage lender (esp. in today's lending environment) is going to look closer at your credit history vs. just your score.

[thirdgenbird]

I'm only a few years ahead of you and I can tell you that paying off our student loans was the best thing we did. For peace of mind if nothing more. We lived cheap. Cheap apartment, no eating out, no driving on the weekends, no tv, we shared internet with two other tenants of the apartment and had no other loans or debt. All of my wife' s income and part of mine went directly to loans.

I did end up buying a house prior to completely paying them, but it was a perfect storm. i live in a very competitive market for "average" homes but the perfect house was available, the market was the lowest I had see it and interest rates were at like an 80 year low. funds I intended to use to pay off the loan were redirected to buying the house but our learned frugalness and a pay raise allowed us to pay off the student loans shortly after buying the house.

The only thing we pay interest on now is our house and if needed, could survive on minimum wage plus savings for quite a while. It's a good feeling.

[fuzzalow]

There are lots of things the bank looks at: what & where the property is (because that is their underlying collateral on the loan) and your other financial assets (stocks, bonds, investment portfolio, etc) that mitigate the bank's risk exposure to the loan.

54ny77 has the simple rule correct: Debt-to-Income ratio is an easy barometer. But it is only one piece.

The Credit score fluctuations don't mean anything - they change slightly with each inquiry or change to your credit history but will in a month of two stabilize to your former historical rank assuming no other changes.

It doesn't really matter what the rate on your loans is, it is the total amount of your indebtedness.

I don't know how banks handle loan risk these days as my financial picture is different than yours. I'd guess if they don't see enough down payment they might not view that as enough skin in the game on your part and they will increase your loan cost to compensate them for your higher risk profile - if they offer a loan at all.

NEVER carry ongoing, recurring credit card debt. It is the purest indication of spending habits above income generation any institution ever needs to see. Free use of unsecured consumer debt is the temptation that disqualifies people from building any financial foundation - always pay the credit card bill in full each month or learn to spend less or earn more income. It is that simple.

[4Rings6Stars]

Originally Posted by 54ny77

it's not the loans in & of themselves that matter, it's your debt to income (dti) ratio once you get a mortgage.

assuming both you & wife will be on mortgage, add up all your combined monthly debt payments, which includes credit cards, student loans, car loans/lease, any other recurring monthly debt, and then the mortgage (which is principal, interest, taxes and insurance). then divide by your household gross monthly income (pre-tax).

if that number is greater than 36%, you need to pay off those debts that impact your dti ratio (or look for a higher paying job!).

a hypothetical example:
total monthly debt obligations: $2,800
total gross income: $5,150
math: $2,800 divided by $5,150 = 54% dti
that's bad.

in that scenario, you'd need to find ~$1,000 in recurring monthly savings to get down to 36% dti. while you can get loans up to 45% dti, that requires reserves and so forth, beyond the scope of this basic answer.

long story short, target your total monthly debt to be no more than 36% of your gross income. that way you'll have a better time qualifying for a mortgage.

that aside, if you have sufficient cash, pay off the student loans. by paying off, you're "earning" a rate of return equivalent to what you'd otherwise be paying on those loans, i.e., you no longer have the liability. there's tremendous psychological value to that.

Interesting and very helpful.

I just checked my budget spreadsheet and did monthly student loan payments + estimated mortgage / total gross income (pretax) for the two of us and came out at 27%.... no car payments or any other debt. So that's promising?

Agreed with paying off the loans being equivalent to earning the interest I'm paying. Just worried about it tanking my credit score and that impacting my mortgage rate...but you're saying worry less about the score and more about the DTI?

[Ken Robb]

It doesn't cost anything to talk with a mortgage loan officer or two. In my 36 years as a Realtor I often found that the best deal came through an independent mortgage broker. These folks work on commission paid by the lenders they represent. If they don't get you a loan they don't get paid. The salaried person at the desk at your local bank is probably not that motivated.

My favorite example: I found a home for a very successful international management consultant who was a Canadian citizen but had been living/renting a home in the USA for several years.

When I offered him contact info for my best mortgage broker he declined because he was such a good customer of Bank of America that he had a personal banker. He knew they would get him the best deal with no hassle. After a few weeks they turned him down because he didn't fit whatever borrower template they used to evaluate his application.

I had him collect his application file from BofA and give it to my broker who had loan approval in a week. Imagine our surprise when the broker told us the loan would be from---get ready--Bank of America! His comment was that "personal bankers" were often just junior trainees in the bank's management program while good brokers could speak directly with senior underwriters. These underwriters appreciate that good brokers can send them a lot of business so they are happy to look at applications submitted that way even if they don't fit cookie-cutter standards.

I have been retired for 8 years so things may be different now but it's worth investigating brokers and direct lenders.

You said you don't want to get involved with a financial adviser now and I get that. You can get good info on how to get the best deal on home loans by speaking with one of these guys. Since home loans now are still around 4% it seems like a mistake to carry student loans at 6%. Interest on home loans is tax-deductible; I don't know if that is true of student loans.

A loan person can tell you about low/no down payment loans as well as conventional programs. Low down loans may carry a slightly higher interst rate than those with bigger downs but even so I doubt the difference would push your rate anywhere near 6%.

Ask around for referrals to good Realtors because they often know some good loan officers. If these people have been in business for 10 years or more you can be pretty sure they are competent and honest because long-term success is usually the result of referrals from happy customers.

[4Rings6Stars]

Originally Posted by yngpunk

A couple of thoughts...

1) Don't know your income level, but suspect that your student loan interest is deductible on your taxes, so might want to take that into consideration when debating to pay off the loan vs. investing the money

2) Have you looked into consolidating your loans into a single loan at a lower interest rate?

3) Depending on how good your credit is, I wouldn't worry about an 18 point drop in your credit score. Besides, any mortgage lender (esp. in today's lending environment) is going to look closer at your credit history vs. just your score.

Thanks for the response.

1 - student loan interest is deductible but only the first $2500. At our tax rate, this saves us ~$350 / year. In the near future though we will start to have this benefit phased out b/c of income level though.
2 - I have looked into this briefly, but it seemed sort of gimmicky and was told it could hurt my credit score... I think I'm learning that I'm probably too afraid of this stupid score
3 - The first 18 point drop didn't hurt much...but I'm worried if I pay off the rest and it drops another 15-20 points, that will hurt. I'm told as long as it's above 730 you're good....another 20 point drop would put me just below that.

[4Rings6Stars]

Originally Posted by thirdgenbird

I'm only a few years ahead of you and I can tell you that paying off our student loans was the best thing we did. For peace of mind if nothing more. We lived cheap. Cheap apartment, no eating out, no driving on the weekends, no tv, we shared internet with two other tenants of the apartment and had no other loans or debt. All of my wife' s income and part of mine went directly to loans.

I did end up buying a house prior to completely paying them, but it was a perfect storm. i live in a very competitive market for "average" homes but the perfect house was available, the market was the lowest I had see it and interest rates were at like an 80 year low. funds I intended to use to pay off the loan were redirected to buying the house but our learned frugalness and a pay raise allowed us to pay off the student loans shortly after buying the house.

The only thing we pay interest on now is our house and if needed, could survive on minimum wage plus savings for quite a while. It's a good feeling.

We are not quite as frugal...but close. Having a baby makes it harder though! The ultimate goal is debt free...

[54ny77]

DTI is among the first steps in qualifying for a mortgage. Other factors are credit scores, reserves (liquid and not-so-liquid, i.e., retirement savings), down payment, and loan to value (amount of loan divided by appraised value).

You've had the student loans, presumably, for awhile and have been paying them on time. That helps establish credit history.

Don't forget to include credit card debt. if you have a balance, it's the minimum monthly payment that factors into the dti.

You can do what's called a soft pull of your credit score for free, via the credit bureau websites. As Fuzz said, it'll swing from time to time depending on what you do, but don't obsesses over it. Lenders have FICO buckets in their loan products, e.g. 680-710, 710-740, that sort of thing. The only thing that matters is that you're in a better bucket, because it'll mean a lower interest rate, generally.

There are a myriad of mortgage products that permit all kinds of variants for one's personal situation (and always come at some sort of cost), but what i'm trying to show here is the very basics. Talk to a good mortgage broker or bank who can walk you through the different types of products and applicable interest rates for your situation. As Ken said, a good broker will typically have more product and rate options and is often the best route, but a local bank (not a big global bank) such as a savings & loan or a credit union can often be very competitive and have a strong likelihood of approval/closing on the initial estimated terms. Especially if they are going to hold your loan in portfolio (meaning they don't just flip it to a loan buyer or sell it to a government agency--assuming it's an agency-eligible loan).

Originally Posted by 4Rings6Stars

Interesting and very helpful.

I just checked my budget spreadsheet and did monthly student loan payments + estimated mortgage / total gross income (pretax) for the two of us and came out at 27%.... no car payments or any other debt. So that's promising?

Agreed with paying off the loans being equivalent to earning the interest I'm paying. Just worried about it tanking my credit score and that impacting my mortgage rate...but you're saying worry less about the score and more about the DTI?

[fa63]

I would pay off the student loans. Start with a clean sheet before you buy a house (aka money trap), if that is what you want. Between my wife and I, we have two houses (one we live in and one rented out) and quite often, wish that we didn't and lived in a rental instead.

I am also not sure if now is a good time to buy a house. I would almost be tempted to wait for the next inevitable real estate bust.

[yngpunk]

Originally Posted by 4Rings6Stars

Thanks for the response.

1 - student loan interest is deductible but only the first $2500. At our tax rate, this saves us ~$350 / year. In the near future though we will start to have this benefit phased out b/c of income level though.
2 - I have looked into this briefly, but it seemed sort of gimmicky and was told it could hurt my credit score... I think I'm learning that I'm probably too afraid of this stupid score
3 - The first 18 point drop didn't hurt much...but I'm worried if I pay off the rest and it drops another 15-20 points, that will hurt. I'm told as long as it's above 730 you're good....another 20 point drop would put me just below that.

I think you worry too much about your credit score impacting your ability to obtain a mortgage or it alone impacting the rate you would get. Might be worthwhile to talk with a mortgage lender or mortgage loan broker to better understand their underwriting criteria. Credit score probably plays more of a role in auto and consumer financing, since it's a simple, easy to obtain measure of "credit worthiness", but after the last mortgage lending crisis, most lenders take a much harder look at your credit history when underwriting a mortgage...even if you have a 730+ credit score.

[yngpunk]

[QUOTE=4Rings6Stars;1825500]Thanks for the response.

2 - I have looked into this briefly, but it seemed sort of gimmicky and was told it could hurt my credit score... I think I'm learning that I'm probably too afraid of this stupid score
QUOTE]

The "usefulness" of consolidation in part rests with who "owns" your student loans and what the terms of the consolidated loan look like. A good place to start is here: http://loanconsolidation.ed.gov/