Qualifying for a mortgage despite massive student loan debt

14 Replies

I'm new to the forum, just heard about it in Brandon Turner's book on rental properties and signed up today. 

I have been learning about real estate primarily through audiobooks and several real estate agents and investors I know locally. I am currently getting my real estate license and am very new to the field. 

I am interested in slowly accumulating rental properties over the next 10 years for eventual passive income (the government takes >50% of a high earned income, which of course I learned about AFTER becoming a doc. Screw that.). So I am very interested in additional passive income now. The one thing that keeps concerning me is my potential to qualify for a loan even once I've saved up a 20% downpayment. 

I'm concerned because my husband and I are both recently graduated doctors and still have a very large combined student loan debt (approx 575,000 combined - I know, it's insanity) plus car loans (about 32,000 combined) and credit card debt (about 11,000). Our credit scores are 650 and 690, and we are rapidly paying down our debt using Kiyosaki's strategy, but it is obviously going to take us a while. 

However, both of our incomes are increasing and our cost of living has significantly decreased recently due to other fortunate circumstances. We do not currently own the house we are in, but do not have to pay rent or mortgage, thankfully. We are saving 10% of our combined income (currently 80k after wretched taxes) for a downpayment on a rental property (either a single family home or a duplex) and should have a substantial amount saved in 3 years (>24,000) as well as all other debt except student loans paid off. Obviously our income will increase but I'm being conservative. We estimate our credit scores to both be >750 at this point if not higher.

I'm curious if anyone else has qualified for a house loan despite having massive student loan debt and what credit score was required, if so. 

I've also just basically put our whole financial statement out there because I'm open to suggestions on the best way to get started. Should we try to pay down the student loan debt before investing in real estate? Has anyone began investing while still in debt? Does our plan sound feasible? What suggestions do you have on our situation? 

I'm a little nervous having put all our humbling financial info out there but I'm excited to be a part of this forum and learn as much as possible! I'm 27 by the way and hoping to turn our situation around by age 36 :) 

Thanks for any help!

-Dr. Jordan Smith

The highest federal tax bracket is now 37%.  The highest GA tax bracket is 6%.  So that's 43%.  If you were self employed, the total self employment tax rate would be 15.3%.  So, that looks like 58.3%.  However, the social security part of that is 12.6% and that only applies to the first $128K of income.  Your last dollar (assuming > $250K AGI, married filing jointly) would only get the medicare part at 3.8%.  That's the regular 2.9% part plus the extra 0.9% for high earners.  So, the maximum rate for your regular income would be 46.8%.  Close to, but not > 50%.  There was a time not so long ago when the top marginal rates were MUCH higher.  The top rate was 50% in 1986 and 70% in 1981.

For qualifying for a mortgage its all about DTI. Add up your debt payments, including a proposed mortgage and divide by income. 38% is the usual max DTI for an OO loan. A non-OO loan can go higher. I've seen a number of up to 51%. However, the income from a rental property is not usually considered as income until you have two years landlord experience.

@Jon Holdman  

Thank you for your reply. I appreciate you breaking down the tax percentages for me and clarifying the total percentage. The new tax laws seem like they will benefit us at this point as well. Still ridiculous, but I have learned a ton about how to keep up with deductions and take advantage of tax benefits this past year. First year filing as a 1099 and not W2. 

Thank you so much for the information on the DTI. I honestly had not heard of it until reading your message. I am scheduling a meeting with my local bank to discuss our financial statement, so this gives me a head start in discussing how they process loan applications.

I just used the information you provided to calculate our current DTI. At this time, we are right at 48% including an approximate 3 bed 2.5 bath avg mortgage in the area. However, we are waiting until we have paid down $59,000 in bad debt (credit cards, car loans, my husband's IRS debt, etc.) before purchasing our first rental property (in less than 3 years). This will take our DTI down to 24%, again including the proposed mortgage and also not accounting for any increase in income, so it may be even lower in 3 years.

We would probably be able to qualify after paying down only half of the miscellaneous bad debt we discussed, but I was planning to save for a downpayment on the rental property as well. 

Do you have any information on how lenders calculate downpayment requirements?

I'm also researching tax law regarding passive income through real estate (i.e. what percentage must be paid on the income after the 2 year experience as landlord that you mentioned). I'm hoping Brandon Turner discusses this in his book on rental properties. I'm only on chapter 4. 

Again, thank you very much for taking the time to read my lengthy message and reply to it. You seem to be very knowledgeable on the topic. 

You can probably find success getting financing as an owner occupant. Most big banks are going to look at your student loans and hit you with 1% of the balance when calculating your debt to income ratio. (At some lenders) On either a physicians loan or FHA loan they will allow you to use your actual student loan payment when calculating your debt to income ratio (which may be much lower based on a different repayment plan.) In general both of those type of loans are only available on owner occupied properties.

Some smaller lenders can also use your income based repayment plan payment instead of 1% of the balance on non owner occupied loans. In reference to the above I max out at a 50% DTI on any loan type. I ave worked for lenders that can do a 56.99% DTI on FHA loans.

To boost your credit score I recommend wiping out the credit cards first. High credit card utilization has the most adverse effect on your score and that debt generally carries the highest interest rates.

If I were in your shoes I would take a look at the interest rates on your student loan debt before considering investing in real estate. I know my federal student loans were at a 6.5% rate. Paying off my loans was a risk free 6.5% return that also greatly increased my monthly cash flow. Your interest rates may potentially be even higher dependent upon on who holds the debt. If you feel confident that your real estate returns will be higher than the interest rate on your student loans go for it. If you have private loans in the 15%+ range you are probably better off paying off your loans guaranteeing that rate of return than speculating in real estate.

"Conventional" loans are those than conform to Fannie Mae and Freddie Mac guidelines. These are your cheapest loan options and will be available with 30 year fixed interest rates. (Those 30 year fixed rate mortgages are one of the things your taxes support.) With these you should assume 20% down for a SFR, 25% for a 2-4 unit property. Rates will be a half to a full point higher than the rates you see advertised. Those advertised rates are for owner occupied loans and investor loans are considered riskier. And so have a slightly higher rate. That said, these guidelines do change. Over four units and once you've exhausted your 10 Fannie/Freddie loans (each of you can have 10, provided each has income to qualify and owns the property only in their own name) you're into commercial loans. These will have similar down payments, slightly higher still rates, and will not be 30 year fixed. Typically these have 5-10 year balloons, ARMs, or fairly short (5-15 year) fixed rate periods.

At first, you'll have to qualify for rental loans just like any other loan. The full PITI payment on the new loan gets added to your other debt payments and the total is divided by your income to calculate a DTI. The rental income is ignored. After two years (i.e., two tax returns that show rental income) the situation greatly improves. Once you meet this threshold, the DTI calculation is different. First, you ignore the rentals completely. Add up all other debt payments and add up all other income. Now, look at the rentals. If the net rental income is positive, it adds to the income number and improves your DTI. If its negative, it adds to the debt payment and hurts your DTI. For existing properties lender will use data from your tax return. For a new property, lenders estimate net rental income as (75% * expected rent) - PITI. Note that I think that formula is a little optimistic, especially if you use a property manager.

A factor here is depreciation.  For rental properties, you get a non-cash deduction that accounts for the fact that the improvements (i.e., the building) degrade over time.  For a residential rental this timeline is 27.5 years.  So, each year you get a deduction on the rental property tax form for 1/27.5 of the value of the improvements.  This can make a rental property that actually produces a positive cash flow have a negative taxable income.   When qualifying for a loan, lenders typically add depreciation back in when calculating net rental income.

Rentals that do end up with a negative net taxable income are often touted as having a tax benefit.  They can, but its not nearly as good as people selling crummy rentals make it out to be.  Rental income is "passive income".  In general, you cannot use a passive loss to offset ordinary income.  There is a "special allowance", though, and this is what sellers tout.   The special allowance is that, if your AGI is low enough, you can use up to $25,000 of passive losses to offset ordinary income.  So, they claim "this property is cash flow negative $50 a month.  But it produces a passive loss of $3000 a year with depreciation.  So you offset ordinary income and save $840 a year in taxes.   So on net you're better off by $240 a year."  There are two problems with those claims.  One is the AGI limitation.  You can take this $25,000 special allowance only if your combined AGI is under $100K.  It phases out by $1 for every $2 of income over $100K.  So if your AGI is over $150K for the two of you then you cannot take these losses each year (more below.)  The other factor is that each time you take (or are allowed to take, if you don't) depreciation, it reduces the basis in the property.  When you sell, the taxable gain on the sale is the selling price, less selling costs, less the basis.  So, every dollar of depreciation you take while you hold the property turns into a dollar of gain when you sell.  Fortunately you can carry forward those disallowed passive losses and use them to offset this gain.  When you sell, the gains up to the amount of deprecation taken (or allowed, if that's more) is taxed as ordinary income, though this is currently capped at 25%.  The remaining gain is taxed as capital gains.

Here's the bottom line.  Buy profitable rentals. Don't pay any attention to this tax benefit monkey business.  The biggest tax benefit is that the income from profitable rentals gets preferential tax treatment and usually has a lower net tax rate than ordinary income.

Jon is spot on with his info in my opinion. If it were me in your position I would work on eliminating consumer debt before moving on to rentals.

I would work on trimming out even more of anything else extra in your budget. I’m not a huge Dave Ramsey fan but he might help in you and your husbands scenario.

Is your husband hopefully a specialty medical doctor or also a chiropractor? Only reason I ask is it’s alarming how two people can attain that much student loan debt and if it had anything to do with spending habits while in grad school. Almost 600k in student loan debt is astronomical if you are both looking at chiropractic salaries as opposed to a medical doctor’s average salary (especially if it’s a specialty such as orthopedic surgery which could explain the additional student loan debt).

Good luck!

Nevermind, read your first post too fast. If 80k is only 10% of your combined incomes I’d just pay off the credit card debt and figure out the first real estate deal while paying everything else down.

@Josh Engelhart

Thanks so much! You're reply makes a ton of sense. Thank you for the additional information on FHA loans. I agree with you on eliminating credit card debt first.

I like what you discussed about weighing out the interest rates on student loans vs the profit from rental properties. I did consider this when initially deciding to begin our real estate investment plan and if we can qualify in 3 years and keep paying the loans down at the same time, it will be profitable still considering our consolidated interest rate even including anticipated maintenance and repairs and such. 

Another issue we have had to consider is that my husband's loans qualify for forgiveness sooner than mine and we may have to pay our tax bracket in taxes on the remaining balance if our assets outweigh our debt at the time of forgiveness. Otherwise if the debt is greater, the entire amount is forgiven. But by then I should hope we are not still in a greater debt-asset ratio. 

I'm happy for you to hear you paid your loans off that must feel nice. We are potentially partnering with a non-profit group as well which could cut the forgiveness time to 10 years rather than 20 as well. 

I just get disheartened at waiting 10-20 years to begin acquiring assets! 

Thank you so much for the reply!

@Dr. Jordan E Smith the biggest mistake I see high wage earners make is buying their first home screwing up their debt to income ratios so they can’t finance investment properties.

"Anotherr issue we have had to consider is that my husband's loans qualify for forgiveness sooner than mine and we may have to pay our tax bracket in taxes on the remaining balance if our assets outweigh our debt at the time of forgiveness. Otherwise if the debt is greater, the entire amount is forgiven. But by then I should hope we are not still in a greater debt-asset ratio. ....

I just get disheartened at waiting 10-20 years to begin acquiring assets!"

If your student debt is all/mostly federal (like mine: 200k at one time), then consider the fact that the debt dies when you do... It's kinda morbid, but a very liberating realization. I discovered this while working myself to death, in the profession that I had worked so hard to obtain... that would never allow me to become wealthy (in spite of the cost to get there).

I agree with the owner occupied advice and house hacking- then you can use the EQUITY from paying down the home loan to fuel future investments- we bought a fixer upper and just got it appraised with over 70% appreciation.

I advocate taking action- I am not good at sitting around waiting to be successful- so working an entire home renovation flip while living in the property and working full time will help a motivated person (guessing you both are like me) to feel they are making progress :)

Having a mortgage worth of student debt is no joke, but one you have the mental shift to realize that minimum payments and maybe never paying it off aren't that bad- you feel much more comfortable starting to build wealth (even if you will have that debt the rest of your life).

Best of luck :)

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If you want to avoid DTI calculations on residential lending, buy an aged LLC with established business credit or start and build one yourself, and invest in commercial where the lending is based on the properties ability to service the debt, not personal DTI.

If you're stuck on residential, the best option since late 2017, is a Fannie Mae direct-lender without overlays, that can take the lowest possible student loan payments reported on your credit reports (as opposed to FHA calculating 1% amortization payments) to calculate DTI, if an income based repayment plan can bring down your monthly student loan debt service.

And if you do both, you can move debt from personal to business and vice-versa to prepare for any lender calculations, depending on what kind of target property.

@Onica Cole  I definitely agree with your mindset! Yeah the only thing I am currently researching is with our type of debt, will we be out of options for a while if we get a mortgage of about 85-100k (planning to buy a little below marker, fix up, and force some appreciation). Like you said, I'm hoping this would give us some equity down the road, but I am wanting to get the ball rolling with our real investments. 

I realize there are many lenders with different qualifications, but did you have any trouble qualifying for a second mortgage despite student loans? If the lender only considers monthly payments in the DTI, it wouldn't make much of a difference for us, but if they consider the total amounts, it would be a different story.

Thanks so much for the reply, sorry for the delayed response - I'm still getting used to this forum. 

@Lane Kawaoka That is one of the issues I was concerned about. Do you have any suggestions on how to avoid this becoming a problem? 

We are currently leaning towards purchasing duplex, triplex, or quad with an OO loan, and living there for a year. I suppose finding a mortgage lender who will consider monthly DTI rather than total would help? Considering we only pay 10% on our loans monthly it is not a large payment..

"did you have any trouble qualifying for a second mortgage" 

We are in a slightly different situation, as my husband is military, but we are using a HELOC rather than a cash out refinance- we researched the rates and found the credit unions to be the best options.... The other option after adding equity would be to sell... Pending market trends, etc.

But as far as qualifying- if you have an appraisal for above the remaining loan amount, it's my understanding that the equity is the main determination for the amount you can borrow... Obviously the interest depends on market and your credit... Maybe the loans will affect that... 

There may be a financial advisor in a better position to answer those questions... I get contacted frequently by financial advisors on LinkedIn, and surely one on BP would be a good option too. ;)

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