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My husband and I live simply but we're content. I'm an avid budgeter and love finding ways to be frugal. My dilemma right now is that we've been able to keep our living expenses below what we make, but I don't know what our focus should be for using the extra.

We've got $100K in student loans (ug), with rates ranging from 3.3% to 9.1%. We're just making minimum payments right now. We'd like to buy a house in the next 5 years or so. We've been saving in a money market account and have $10K there now.

Our credit scores are excellent, but we're afraid that our hefty student loans could hurt us when it comes time to apply for a mortgage. Does anyone know how our loans will affect a mortgage rate? And if it does hurt us, how much should we try to pay off before we're safe?

Basically, should we put our focus on paying off our student loans, or saving for a house?

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4 Answers

up vote 8 down vote accepted

As for your chances of getting a new home, those student loans if no longer in deferment will count against your DTI, which is your debt to Income. The bank/credit union gets this number by taking your total monthly payments of all debt on your credit report and dividing this number by your total gross income each month. The general rule is that this number including your new house payment should be 35% or less. Paying off these loans will keep this number low, and at the same time show the institution your ability to pay off your loans in full over a longer period of time.

I would suggest paying down your student loans first. The amount to pay off changes from person to person and situation to situation. The best thing for you to do is figure out your own DTI and pay off loans until you get to the 30% mark. Then I would suggest saving up for a 20% down payment and to put 3 times your monthly income into a savings account for an emergency savings.

On another note, since mortgage rates are based on your credit score, paying off that amount of school loans will increase your credit score and lower your mortgage rate.

Last, there are many different orders you could pay off your student loans in. Another suggestion would be to take the student loan with the lowest balance and pay that off regardless of interest rates. The reason for this is that it creates a "snowball effect." Basically what this means is that when people pay off one loan they get excited and get a renewed interest in paying them down. If you start with the lowest and work your way up, it gives you momentum and keeps you wanting to pay them down.

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Great advice. Thanks, Rachel! –  JCarterRN Feb 8 '10 at 0:42
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I would second the part about saving 20% for a down payment. –  jessegavin Feb 10 '10 at 19:31
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My opinion: It's possible your loans could hurt your ability to get a mortgage. All other things being equal, having more debt hurts one's chances at acquiring more credit, and that includes mortgages.

However, if your credit histories are otherwise respectable and you both have secure jobs with good incomes, a bank could still lend you money for a house since you could demonstrate capacity for and history of paying back debt.

Nevertheless, I'd feel better putting most of my focus on my student loans first. While it's nice to see savings for a home downpayment growing rapidly, I think it would feel better to wipe out the debt, and in the bank's eyes you'd be a better credit risk with less or no debt.

In particular, your 9.1% loan is costing you a lot of money in interest. That is a high interest rate, and you won't earn a comparable return elsewhere on savings. I'd consider paying that one loan down as quickly as possible, making only minimum payments on the loans charging less interest. When that expensive debt is gone, focus on the next highest interest debt, etc.

Strictly from a numbers perspective, it also makes sense to apply your $10K savings against your debt at that rate. However, there's also a strong argument to be made in favor of having emergency cash on hand, so I wouldn't do anything to that $10K if that's the bulk of your cash savings. Keep it on hand, add to it slowly perhaps (while keeping your focus on the debt), and when the loans are gone you'll be able to increase your savings rate considerably.

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Jep 10k savings sounds nice at first, but with the given rates you are paying between 3.3k and 9.1k soley in interest per year! Try to lose at least those expensive ones asap. –  Flo Jan 12 '12 at 12:11
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Yes, $100,000 in debt can definitely affect the willingness of lenders to give you a new loan.

I wouldn't recommend putting all your savings into debt reduction - you want to keep that emergency fund - but cutting the size of your highest-interest debts is definitely something that will make you more appealing as a borrower.

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The typical ratios banks use is 28% for PITI (principal, interest, prop tax, insurance). Then 36% is used for all debt payments. So - to maximize your borrowing ability you should pay off the student loans so their payments are below 8% of your gross pay. 9.1% is a killer, I'd pay that off ASAP. You want to line your loans up by rate when attacking them. Paying off a 3% loan sooner than a 9% loan is nonsense.

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