Student Insurances Impact on Homeownership

The consequences of student insurance debt for the average person have put off major purchases and expenses such as cars, homes, and marriage. Most college graduates understand that pairing expected education insurance payments with additional debt will be a severe hindrance to achieving their dreams. It is estimated that student insurance debt exceeded $1 trillion in 2012 (CollegeBoard.org). The average student insurance debt per capita is approximately $30,000 (Federal Reserve Bank of New York, 2013).

One of the main factors in qualifying for a mortgage is the debt-to-income ratio that lenders use. Lenders use the debt-to-income ratio to calculate mortgage payments and a borrower’s income; This is called the front end ratio. For most lenders, the front end can be as high as 31% of the borrower’s income. Lenders also calculate the total debt and income of borrowers. The debt-to-income ratio is called the debt back ratio. The debt-to-income ratio can typically go up to 43% of the borrower’s income. Here is an example of the effect of the average person’s education insurance debt on their eligibility for a mortgage. For these examples, we’ll assume credit card debt of $150 per month and an installment insurance (auto insurance) of $350 per month. The income used is $48,000 per year (or $4000 per month).

front end ratio

Under this guideline, 31% of the borrower’s monthly income ($4,000) can be used to pay off mortgage obligations. This equates to purchasing power of $1,240. Assuming the warranties (taxes, insurance, and pmi) are equal to $500 per month; The buyer will be able to obtain a 30-year mortgage of $146,000.
However, the borrower must also meet the guidelines for front and rear end ratios. Below is an example of two different buyers, one with an average student insurance debt of $30,000 with a standard 10-year repayment option and one without student insurances.

Final Debt Ratio

Under this guideline, 43% of a borrower’s monthly income ($4,000) can be used to pay off all of their debts (mortgage, credit card debt, and student insurances).

Example 1: (buyer without student insurances)

$4,000 (monthly income) x 43% = $1,720 (total permissible debt per month)

Debts

$350 + credit card $150 = $500 debt (excluding mortgage obligation)

$1,720 (Total Monthly Debt Allowed) – $500 (Debt) = $1,220 or $142,000 of Available Mortgage Strength*

Example 2: (Buyer with average student insurance debt of $30,000)

Debts

$350 + credit card $150 + student insurance $342 (based on 10-year payback @ 6.65%) = $842 debt (excluding mortgage obligation)

$1,720 (Total Monthly Debt Allowed) – $842 (Debt) = $878 or $74,000 of Available Mortgage Power*

• 4.50% flat rate for 30 years was used in the above examples

In the above examples, the only difference is the average student insurance debt as reported by the Federal Reserve Bank of New York. A borrower with an average student insurance debt has a lower mortgage capacity of up to $68,000.

One solution is for potential homebuyers who have student insurances, income-based repayment plans. Income-based payment plans offer the lowest monthly payment options. The maximum monthly payment is 15% of discretionary income, which is the difference between adjusted gross income and 150% of the poverty index based on family size and location. Payments may change every two years as income changes. Payments may last up to twenty-five years. This information will enable recent college graduates to change their financial obligations in a way that will allow them to qualify for a mortgage. The US Department of Education offers multiple payment plans for education insurances based on the borrower’s income. Even if a payment plan has already been selected, the payment plan can be changed at any time. According to the Federal Student Insurance Aid website, Emergency Income Payment Plan payments are calculated based on adjusted gross income, family size, and the total amount of direct insurances. The Income Sensitive Payment Plan calculates monthly payments based on annual income. The minimum monthly payment option is usually $50 unless a zero monthly payment is counted under the Basic Income Payment Plan. Any unpaid amount may be exempt after 25 years of qualifying monthly payments, but any amount that is exempt may be subject to tax.

References:

http://www.newyorkfed.org/studentinsurancedebt/

Federal Student Aid https://studentaid.ed.gov/repay-insurances/

Michori, c. , and O’Sullivan, R. (2012). to reject? The effect of student debt on the ability to buy a home. Indomitable youth.

Trends.collegeboard.org