The Effective Federal Funds rate has risen from 0.12% in November 2015 to 1.3% in December of 2017. For borrowers, that could spell rising interest rates on everything from mortgages and student loans to credit card debt.
If you’re considering a home mortgage refinance, the first half of 2018 may be the right time to make your move.
However, homeowners who still have lingering student loan debt need to pay careful attention to be sure they qualify to refinance. There are additional considerations to make, especially if you are taking advantage of an income-driven repayment plan.
Here's what you need to know.
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Know Your DTI
Your debt-to-income (DTI) ratio is the ratio of your minimum monthly debt payments to your average monthly income. When you refinance your home, you’ll need a DTI below 45% in most cases.
You may assume that you’ll have no trouble qualifying for a loan refinance based on your income, but not everyone should be so sure.
For example, people who earn most or all of their income from self-employment activities often have a tough time validating their stable monthly income.
Combine a difficult to validate income with high monthly student loan payments, and you’ll start to see why banks may not want to underwrite you.
Additionally, if you and your spouse have lingering student loan debt, but one of you dropped out of the workforce, refinancing could be trouble. The lower income combined with the student loan debt could push your DTI above the required threshold in some cases.
If your student loan debt is Federal debt, you have options for lowering your DTI. Consider whether it makes sense to put your loans on an income-driven repayment plan. In many cases income-driven repayment plans will lower your monthly obligation (as low as zero dollars).
For the purposes of underwriting the loan, your obligation under the income-driven repayment plan counts (not your standard monthly payment). This is a change from a few years ago, and it makes refinancing with student loan debt more accessible. However, some lenders do follow their own (stricter) internal policies. Read more about refinancing a student loan while on IBR or PAYE here.
If you don’t qualify for an income driven repayment plan, you may want to consider making an effort to pay off one of your loans before applying for a refinance.
This will lower your monthly financial obligation and reduce your DTI. Alternatively, you may want to refinance your existing student loans to a lower interest rate and a lower monthly payment.
Student Loans In Default Could Spell Refinance Disaster
Homeowners with student loan debt in deferment or forbearance don’t have to worry that their debt will prevent a refinance, but having a student loan in default could spell disaster.
Depending on the amount of equity you have in your home, you need a minimum credit score between 620-700 to refinance your loan. Most people who have a student loan in default won’t have a high enough credit score to refinance their mortgage.
Whenever possible, rehab your student loans through Federal debt consolidation or by agreeing to a new payment plan for private loans.
Cashing Out Refinances To Payoff Student Loans No Longer Makes Tax Sense
In the past, some people used cash-out mortgage refinances to pay off their student loans. This allowed them to lower their interest rate, and maintain tax deductible interest.
With the passage of the new tax reform bill, that strategy doesn’t make much sense. Student loan interest is still deductible, but home equity refinancing (ie cash-out mortgage refinances) no longer qualifies for a tax deduction.
Borrowers may want to consult with a tax-professional before making any big moves related to cash-out refinancing.
However, potentially using a service like Point to sell equity in your home could still make sense.
Robbing Peter To Pay Paul?
One of the primary drivers behind mortgage refinancing is to lower your monthly mortgage payment. Free cash flow is an awesome benefit, but it’s not always a money savvy move. If you feel a cash flow pinch, refinancing your mortgage is an expensive way to free up cash.
The average origination fee and discount points is .6% on a 30-year mortgage. That means refinancing a $230,000 costs $1380 in origination fees alone. Add to that appraisals, and other miscellaneous fees and you could pay several thousand dollars to refinance.
Refinancing your mortgage, so you can pay your student loans means your robbing yourself of home equity to pay another type of debt. If you really need the cash, consider refinancing your student loans, getting on an income driven repayment plan or better yet increasing your income.
Are You Ready To Refinance Your Mortgage?
However, take a little time to be sure that your refi strategy makes sense with your overall financial plan. When you have multiple debt types, you want to be strategic as you eliminate your debt and build wealth.
Have you thought about refinancing your mortgage despite having student loan debt? Why or why not?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.