If you know two things about Debt Discipline, we despise debt and we're fans of Dave Ramsey. A recent discussion popped up about student loan debt and homeownership. We'd like to dig in a little deeper on the topic.
A topic about mortgages appeared recently on Dental Town, which is the world's largest online community for dentists. The post discussed a video (see below) in which the wife of a recent dental school grad called in to get some advice on whether she should pay off their student loan debt before buying a house. In typical Dave Ramsey fashion, he aggressively answered her question.
She informed Dave that his first-year salary was going to be $120,000 and that he had amassed $480,000 of private school student loan debt. Ouch!
Her question to Dave was, “Should we continue renting, or can we purchase a home with student loan debt?”
An Overview of Rising Dental School Debt
According to the American Student Dental Association (ASDA), 2017 dental students graduated with an average dental school debt of $287,331—an increase from years prior.
If historical trends continue, it is likely the debt load will continue to grow in both dental and medical school. Nothing ever gets cheaper, right?
Private Dental Schools vs. Public Dental Schools
Just like college, the amount of debt dental/medical students accumulates greatly depends on where they choose to attend school. On average, public schools offer lower tuition rates than private schools.
I know many times, college students trying to get into medical/dental school will apply to multiple schools and hope they're accepted to any one of them. One recommendation would be to take some time to compare the financial differences between the schools you're applying to.
Whenever I was applying both to dental school and then to a residency, the cost of tuition played a major factor. Some of the private schools with higher tuition rates were MUCH easier to get into than some of the lower cost public schools. I wanted to limit the amount of student loan debt I was going to have to repay so I kept my list short with only public schools.
Should You Buy A House With Student Loan Debt?
In the above video, Dave Ramsey recommended that the new dentist pay off his $480,000 of private school loans and continue renting BEFORE buying a house.
What do you think? In this situation, I would tend to lean more toward paying off the loans before acquiring more debt. I agree with Dave on most of the things he preaches and this is one of them.
Too many doctors complete training with loads of student loan debt that they keep around too long. I know a local pediatrician that still owed over $100,000 after practicing for 20 years!
I get it. Having an above average income tends to make one feel that having a couple of loans lying around is no big deal. Complacency sets in. Unfortunately, those loans start to multiply as doctors tend to want to keep up with the Joneses (and the Joneses are broke).
4 Reasons To Pay Off Your Student Loans Before Buying A Home
1) Your debt-to-income ratio is too high
When lenders decide whether you qualify for a mortgage, they review how much of your monthly income is devoted to debt repayments, such as payments for:
- student loans
- credit card debt
The overall result is your debt-to-income ratio (DTI). This ratio further breaks down into:
- Front-end ratio: The percentage of your income consumed by mortgage expenses
- Back-end ratio: The percentage of your income consumed by all other debt
For the most part, lenders want potential homeowners to maintain a front-end ratio of no more than 28% and a back-end ratio no more than 36%.
For doctors and other high-income professionals, some lenders allow back-end ratios as high as 43%.
If your back-end DTI is roughly 30%+, it’s probably best to continue renting until you've paid down more debt.
Remember, as a doctor, lenders will tend to loan you more money. But just because you qualify for a loan doesn’t mean you should take one out.
2) You don’t have enough for a down payment
A report from the National Association of Realtors revealed the typical home down payment is 6% or less for 60% of first-time home buyers.
Typically, if your down payment is less than 20%, then you're required to pay private mortgage insurance (PMI). PMI can add 0.5 to 1% to your monthly mortgage payment.
If you purchase a home for $200,000, for example, then you could face an extra $83.32 to $166.64 each month in PMI.
What about doctor mortgage loans?
Here's what the White Coat Investor has to say:
The definition of a doctor mortgage loan is one that:
- Does not charge PMI despite having a down payment of less than 20%
- Will close with a signed employment contract rather than pay stubs
- Only considers the payments of student loans (not the entire loan burden)
- Is not an FHA or VA loan
As a general rule, the rates and fees on these loans will be slightly higher than what you can get with a 20% down conventional mortgage. That’s the price you pay for the convenience of not having to meet conventional mortgage rules and for being able to use your down payment money to:
- pay off student loans
- max out retirement accounts
The terms are highly variable and include:
- 30 year fixed
- 15 year fixed
- 5/1 ARMs
- 7/1 ARMs
- 10/1 ARMs
3) You want to avoid being house poor
We rented for over ten years while I was in training. After purchasing our first home, I had no idea the amount of additional recurring and sometimes unexpected expenses that homeownership brought along with it.
Besides regular maintenance costs, you must factor in other repair expenses such as:
- leaky roof
- the furnace breaks
- when the A/C unit goes caput
- when the wife wants new furniture!
A good way to avoid this is to have a buffer in your budget to absorb these additional costs and consider purchasing a home that is less than the amount you're qualified to buy.
4) Because Dave says so
If you're an avid follower of Dave Ramsey and you agree with the mortgage advice he gave to the caller in the video above, then, by all means, pay them off.
Looking back, our marriage would have had much less stress early on if we had done it this way.
3 Reasons To Buy A Home When You Still Have Student Loan Debt
1) Your debt-to-income ratio is less than 28%
If your front-end ratio (the percentage of your income consumed by mortgage expenses) is significantly less than 28 percent, then you should be in good shape to:
Consider obtaining a mortgage while being able to pay back your student loans aggressively.
2) You’ve saved up a LARGE down payment
If you've been able to save up 20%+ for a down payment while accelerating your student loan payments, then you might be ready to take on a mortgage.
3) You have a student loan with a low monthly payment
If your student loan payments are a little too high for you to comfortably afford a mortgage, you may be able to refinance or consolidate your student loans, which means you could qualify for a lower monthly payment.
Even if you can get it lower, make sure you consider the other advice mentioned above before purchasing a home.
Dave Ramsey Mortgage Advice
If you’re going to buy a home with a mortgage, you need to have the basics covered.
Here’s what Dave recommends:
- You’re completely debt-free.
- You have three to six months of expenses saved in an emergency fund.
- You’ve saved at least 20% for a down payment to avoid PMI payments.
How Much House Can I Afford?
Now that you've gotten a little Dave Ramsey mortgage advice, let's take a look at how much house he recommends we can afford.
Calculate the Costs
If you're married or soon to be, it's important to get on the same page as your spouse. It's extremely difficult to obtain financial freedom when one spouse isn't on board with the other. Buying a home is no exception, it's all about the numbers.
Here are the 4 steps Dave recommends when figuring on how much house you can afford.
1) Add up the monthly household income
If you bring home $6,400 a month and your spouse makes $3,600 a month. Your total monthly take-home pay would be $10,000.
Don't forget to add in any money from side-gigs too.
2) Multiply your monthly take-home pay by 25% to get your maximum mortgage payment.
If you earn $10,000 a month, that means your monthly house payment should be no more than $2,500.
His housing rule of thumb is quite different than the recommendations you’ll find elsewhere.
3) Use Dave's mortgage calculator to determine how much house you can afford.
Here’s what his calculator determines a person or family can afford with:
- Home price of $600,000
- Down payment of 10%
- 15-year fixed mortgage
- Interest rate = 4.25%
- Private mortgage insurance (PMI) of $225 a month
- Property tax = $6,600 a year
- $846 in homeowners insurance cost
Sticking with our example of the family with an income of $10,000 a month, they couldn't afford the above house as their recommended monthly mortgage payment should be no more than $2500 a month.
In the above example of a mortgage payment of about $5,000, that would mean you’d need take-home pay of $20,000 per month.
Dave has an alternative calculator where you can input your monthly take-home pay to obtain the calculation:
I actually like this one better as it also breaks down the home prices based on the amount of down payment you can make.
Remember that when you obtain a mortgage pre-approval, lenders will likely approve you for a loan amount with payments larger due to your above average income.
That may tempt you to take on more home than you should. Don’t just assume that just because the bank approved it, you can afford it. They are two very different things.
After gaining Dave Ramsey mortgage advice, how much house do you think someone can afford?
The article was originally published on The Money Mix and is published here with permission.