Having your mortgage application stopped dead in its tracks a few days before closing is everyone’s worst nightmare. Student loan refinancing can be exactly the right choice taking control of your debt. Unfortunately, underwriting may not see it this way, so refinancing student loans before getting a mortgage can be a problem.
Kellie, a Student Loan Planner client, shared her struggles with refinancing student loans before a mortgage.
Kellie’s successful student loan refinancing
Kellie has been a general dentist for two years. In January 2018, Kellie refinanced her student loans with CommonBond for a seven-year plan. Her payments with this plan are about $2,300 per month.
“I feel great about the progress I’ve made paying down my student loan debt,” Kellie states.
She and her husband have been living with his mother for two years to help decrease the couple’s debt so she could buy a dental practice. This plan has worked so far, and Kellie purchased a practice in January 2019.
This couple of 28-year-olds are making smart financial choices early in life. They both decided the next focus would be on starting a family and finding the perfect home in their small town.
The mortgage application pre-approval was on track
Kellie and her husband contacted Huntington Bank to ask about its doctor home loan. She heard it was the best mortgage for doctors. The loan looked good with no down payment or Private Mortgage Insurance required and an interest rate of 4.325%.
From the start, Kellie informed the loan officer that she had recently purchased a practice earlier in the year. The loan officer said it wouldn’t be a problem. In fact, according to Kellie, the loan officer acted 100% confident that they would qualify for the mortgage program.
In 2018, their combined income was $233,000. Kellie and her husband were promptly given a pre-approval letter for $500,000. They had already set a modest home budget of under $200,000, so everything seemed to be on track.
The next best part was that they found a home. The couple paid $400 for a home inspection and put $1,000 of earnest money down.
Kellie and her husband jumped through all the hoops and were set to close on a Friday.
36 hours before closing day, their loan was denied
Monday rolled around, and they hadn’t heard anything from the bank. Kellie gave the loan officer a call, who said their mortgage application had been advanced from the underwriter’s desk to the underwriter’s manager’s desk.
Thirty-six hours before closing day, Kellie learned their mortgage loan had been denied.
They were likely not going to get financing from another bank in 36 hours, and the sellers weren’t willing to extend the home purchase contract. The couple lost their earnest money and the home where they had hoped to start a family.
Behind the scenes of the mortgage application
Huntington Bank has a policy that any self-employed applicant must have at least one year of corporate tax returns to be eligible to apply for a mortgage. Despite being a dentist at the same practice for the last two years, Kellie had now become self-employed as the owner. Huntington told Kellie that because of this new ownership position, her income couldn’t be verified.
The bank removed Kellie’s income from the mortgage application but not her student loan debt. Instead, her husband’s income was used on the application, which couldn’t afford both the mortgage and Kellie’s student loan payments.
Refinancing student loans before a mortgage can help or hurt
Refinancing your student loans can cause a hiccup in the process when it comes to debt-to-income (DTI) ratio. Your DTI ratio is the percentage of your total gross monthly income that goes toward debt.
This is what happened with Kellie. Once her salary was removed from the application, this changed the couple’s DTI ratio. With a new practice and student loan payment on a seven-year payoff plan, the couple’s DTI ratio was high. In general, it’s best to keep your DTI ratio around 36% to get approved for a mortgage.
In Kellie’s case, the loan officer suggested that she refinance her student loans again to decrease the $2,300 payment. Refinancing your student loans to lower your monthly payment can be a solid strategy, and even though Kellie recently refinanced her student loans, she could refinance student loans more than one time.
Kellie looked into this option, but found it was a dead-end road. This is because refinancing student loans required two years of corporate tax returns for self-employed applicants.
For Kellie and her husband, they had no solution to address the new DTI imbalance, since she couldn’t refinance her student loans and her income couldn’t be verified.
Kellie’s future plans
Kellie has a positive outlook on her house hunt. “I know everything happens for a reason, and there will always be another house,” she says.
She cautions those looking to refinance student loans before applying for a mortgage. “…there comes a time to balance paying down debt aggressively with living life and raising a family,” she says. “I am so grateful to own my own practice, but I never thought that purchasing the practice [and becoming self-employed] would put the brakes on purchasing a home or our family planning timeline.”
Your experience getting a mortgage might be different
There are other factors involved when refinancing student loans before getting a mortgage that weren’t a part of Kellie’s story.
Your credit score is a major factor in buying a home. Refinancing student loans right before a mortgage can have an impact on the credit score your lender sees. A refinanced student loan is a new loan, which shows ups that way on your credit report.
Other than refinancing your student loans to lower the monthly payment, you could try switching payment plans. If your federal student loans are on the Standard Repayment Plan, switch to an income-driven repayment plan to lower payments. You can use a calculator to estimate your payments on these plans before applying for the change.
Don’t forget that a good payment history with all of your student loans is a plus when applying for any type of mortgage. Each mortgage lender has its own set of rules. You can take a deep breath knowing that student loan debt and refinancing won’t always stop you from getting a home.
One option to look into is White Coat Investor, which has a page for physicians, dentists and medical professionals. Physician mortgages offer a low down payment and do not require mortgage insurance. The most significant part is that a physician mortgage allows higher student loan balances than conventional or Federal Housing Administration (FHA) loans.
There are a ton of hoops to jump through when buying a home. Make sure refinancing your student loans doesn’t stop all of your efforts days before closing as it did for Kellie.