It is very common for a lot of young home buyers to still have some student loan owing while they are looking to buy their first home. The required payments from a salary, particularly someone new to an industry or starting out in a job, often aren’t enough to quickly pay down the amount borrowed to study for a degree or new trade.
When you are applying for a mortgage, debt affects the amount that you can borrow because it reduces the amount of income that you have left from your salary.
In the case of credit cards, the bank must assume that you will max out your limit. A credit card therefore, roughly reduces the amount you can borrow on a mortgage by $46,000 for every $10,000 you have as a limit. If you’ve got a $20,000 limit on your credit card, you will be able to borrow $92,000 less than an identical person without that limit.
But student loans are different because your repayments are always based on the amount you earn, not the amount you owe. So two people earning exactly the same salary will make the same payments on their student loan even if one person owes $3,000 and the other owes $300,000. Yes, there are people that owe that much on their student loans!
Start your property search
This is a strange concept to get your head around. In some cities, it’s plausible for a recently graduated doctor, for example, to have a mortgage and a student loan of almost the same amount but the banks aren’t overly concerned because the payments are the same no matter how much they owe. Try getting a mortgage with a $300,000 credit card limit!
The question often comes up with mortgage applicants as to whether they should pay off their student loan so they can borrow more. To know whether paying off your student loan is right you must be able to answer 2 questions: is income, not deposit, stopping you from borrowing more money? And, if you do pay your student loan off, will you still have enough deposit to buy a home?
Let’s look at an example of two almost identical buyers.
They both have a $54,000 deposit saved and have both been told that it is their income that is stopping them from being able to borrow enough to buy a $500,000 home. The difference is, one person has a $4,000 student loan and the other has a $20,000 loan.
The first person could pay off their $4,000 loan and still have 10 per cent deposit - or $50,000 - for their home. It’s difficult, but not impossible, to buy a home with 10 per cent deposit so all else being equal, this person should consider paying off their student loan.
But if the second person paid off their $20,000 loan, they would have more income to put towards a mortgage but would now have only $34,000 deposit for their home. This person needs to consider buying a cheaper home or finding a way to increase their income.
The bank or mortgage broker will almost always be able to tell you if it is your income that is stopping you from borrowing more. From there, you will be able to calculate whether reducing your credit card limit or paying off your student loan will be able to free up enough income for you to get the home that you want without using up your deposit in the process.
- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.
