How Does A Student Loan Affect A Mortgage Pre-Approval?

Date Published: 15 March 2020

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So, you’ve studied hard for many years and, to get there, you received a Student Loan.  For your courses, for your books, and for some money to live on.  Now you have a deposit for a house and a Student Loan of 4 times that!  How can you tell the bank your Student Loan is going to take you longer than your mortgage to pay off?

What are the 2 Hurdles of getting a mortgage?

If you read our blogs often, you will know that people usually face one of two hurdles when getting a mortgage. 

• a Deposit Hurdle (you don’t have enough deposit) or,
• an Income Hurdle (you don’t have enough income to cover all expenses).

Student Loans reduce your income (the government takes out 12% of your salary once you earn more than $19,084 per year).  The banks simply take that amount off your income when they’re calculating how much you can afford.  Basically, a Student Loan makes it so you hit the Income Hurdle earlier.

How much does my Student Loan affect my mortgage pre-approval?

This is the most important thing to understand about the bank’s calculation. It actually doesn’t matter how much you owe on your Student Loan; the bank will reduce your “useable” income regardless. 

This is great news for those of you with eye-watering Loans.  The calculation is the same whether you $3,000 or $300,000 remaining.  The bank simply doesn’t care.  They would care if you had a $300,000 Credit Card (obviously) but not a Student Loan.  Why?  Because your payments will always be 12% of your income and no more.  The government can’t call your loan in and the payments are made automatically.  It’s even interest-free, as long as you stay in the country.  It is as close to good debt as you can get.

So don’t be embarrassed about the size of your loan.  We’ll adjust your income and work with it.

Note that these calculations and rules aren’t unique to New Zealand or NZ Banks.  They are common practice overseas too.

Should I pay off my Student Loan if it is only small?

If you are hitting the Income Hurdle (you have enough deposit but your income is holding you back) and only have a small Student Loan left, consider paying off that Student Loan.  Sure, you’re paying off an Interest Free loan which isn’t ideal, but you’ll get a 12% income boost which might get you what you need.

The key thing to consider is: can I pay off my Student Loan without affecting the deposit?

So let’s say all your savings add up to a 10% deposit and you are looking to buy a home. You couldn’t use any of that money to pay down your Student Loan because you would then have less than 10% deposit which makes it increasingly more difficult.

If, however, you had a 12% deposit and couldn’t borrow as much as you wanted because your Student Loan was restricting how much income you had, you could use the 2% of the deposit to remove the Student Loan. This would still leave you with a 10% deposit and more income to put towards your mortgage!

Should I save for a home deposit or make additional payments into my Student Loan?

The answer to this the same as whether you should pay it off totally. Student Loans are not necessarily a bad thing if you have plenty of income to pay for a mortgage. The key question is, do you have enough deposit to buy a home? If not, and your goal is to purchase a home soon, then we suggest the following steps:

• Set a Purchase Price Goal for your new home. It might be $400,000 in some parts of NZ. It might be $800,000. Know what you are are aiming for.
• Have at least a 10% deposit for your Purchase Price Goal. If you are aiming for $400,000, then your cash savings, KiwiSaver and (potentially) First Home Grant should be at least $40,000.
• Meet with a Mortgage Broker to calculate if your income is enough to purchase your Purchase Price Goal. Any Adviser will be able to tell you if your current income is enough to get your mortgage. If not, it’s time to consider paying down Credit Card debt or your Student Loan.

I don’t have income for the mortgage I need. Should I pay down my Credit Card or my Student Loan?

A very interest question and quite an involved one (with lots of numbers)! Let’s see if we can break it down into what we know:

• Credit Cards are usually around 15%-20% interest rate
• Student Loans are typically 0% interest rate

It’s therefore more financially responsible to pay off your Credit Card. But, paying down your Credit Card may not affect your income enough to get you your mortgage.

Example

Let’s say you have a $5,000 Credit Card and a $5,000 Student Loan. You have $5,000 cash which you could use to pay one or the other off (but not both!). Let’s say you earn $70,000 per year and that using your $5,000 cash doesn’t affect your deposit.

The minimum payment for a Credit Card is 3% per month so a $5,000 Credit Card lowers your income by $150. If you paid off your Credit Card, you would now be able to put that $150 onto your mortgage.

If you earn $70,000 per year, you are required to pay ~$500 per month towards your Student Loan. If you paid off your Student Loan, you would now be able to put that $500 onto your mortgage.

So the financially responsible method is to pay down your Credit Card (because it is on 15%-20%) but paying off your Student Loan means you are much more likely to get a mortgage approved.

Example 2

Things would be quite different if you had $5,000 savings, a $5,000 Credit Card but this time a $10,000 Student Loan. Why? Because paying off $5,000 from a $10,000 Student Loan doesn’t affect your useable income at all. You still need to pay $500 per month into your Student Loan and $150 per month into your Credit Card. So in this case, using the $5,000 to pay down your Credit Card would be the best option as it would free up $150 per month to use towards your mortgage.

Summary

Paying off your Student Loan is not a simple decision. The first thing you must decide is what your Purchase Price Goal is. Then decide whether you have (ideally) at least a 10% deposit in savings. And then, if your income is not high enough to get your Purchase Price Goal, consider what debt will most increase your useable income for your mortgage.

Mortgage Lab’s mission is to be the digital town square for financial decision-makers to gain knowledge about their current and future mortgage. Follow us on Facebook and LinkedIn or subscribe to our newsletter to be notified of our latest articles.