For many student loan borrowers the opportunity to buy a house and the opportunity to refinance student loans happen around the same time. Both a refinance and a mortgage require good credit and a healthy debt-to-income ratio.
Because a refinance can affect a mortgage application, and a mortgage can affect a refinance, it is very important to come up with a smart strategy when planning these financial endeavors.
Credit Score Implications
Many people believe that the big issues is the application process and the ding their credit score takes when attempting to get a mortgage or refinance student loans.
While there is a drop in credit score when applying for new credit, it is usually temporary and not very large. For borrowers repairing their credit and worried that about even a slight drop in score, it will be important to prioritize the more critical of the two applications. For those with excellent credit scores, this factor probably isn’t the biggest concern.
Debt-To-Income Ratio Changes
The way a student loan refinance can really impact a mortgage is the debt-to-income ratio. Debt-to-income ratio is the main number lenders use to determine if a consumer can afford a new loan. Borrowers who select a short repayment plan for their student loan refinance might get a really favorable interest rate, but the monthly payments may be higher and as a result will lower their home buying ability. On the other hand, selecting a long repayment plan can lower monthly student loan minimum payments and enhance a borrowers ability to buy a home. Even if the borrower is making extra payments towards their loan, lenders will only be concerned with the monthly minimum payment.
The other of this equation is that buying a home creates new debt and can make refinancing student loans more difficult. This is especially true for borrowers who have low housing costs and are considering a large home purchase.
Which Comes First?
Any strategy selected should account for the relative importance of the loan at issue. Someone considering buying a $300,000 shouldn’t let an $8,000 student loan refinance get in the way. This person should probably focus their efforts first on getting the mortgage squared away and then move on towards the student loan. On the other hand, if someone has six figures worth of high interest student loan debt and an opportunity to get substantially lower interest rates, the student debt may be the bigger concern.
Time Mostly Heals All Wounds
Any overlap between these two processes can cause confusion and issues. If possible, put some distance between the two. By waiting six months or even a year, the dust can settle on the first decision and a borrower can focus their efforts on the second.
Doing both close in time can cause issues in a number of ways. First, a student loan being refinanced might show up twice on someone’s credit report. The original loan(s) to be paid off may still appear while the new loan does as well. This is usually a temporary problem, but when trying to finance a house, it can be a major issue.
A Crafty Alternative
If this issue is potentially on the horizon, one way to handle it would be to do a double student loan refinance.
Long before the mortgage process starts, look into refinancing student loans on a 20 year repayment term. This will reduce the minimum monthly payment to as little as possible and help the debt-to-income ratio. By doing this early, the credit score considerations are also minimized.
With the improved debt-to-income ratio, getting a mortgage should hopefully be easier… especially if it is done long after the refinance is finalized.
Once the mortgage is in place, the previously refinanced student loans can be refinanced again, this time by choosing the lender offering the lowest rate, rather than just opting for the lowest payment. There is no rule against refinancing student loans multiple times.
For most student loan borrowers, the mortgage will be the bigger purchase and the bigger consideration.
One helpful resource in evaluating options would be to talk to a mortgage broker. A good mortgage broker should be an expert at getting loans approved and be able to offer advice on the potential impact of refinancing other debt.
A student loan refinance and buying a home are both major financial decisions. These decisions can also impact each other. Before jumping into either process it is important to consider how they work together.