You have student loan debt, but you also have dreams of owning your own home, going to graduate school, getting married, or buying a new car. If you don't have the money set aside to pay for those things in cash, you'll likely have to borrow.
How should your debt from student loans affect your decision to take on more?
Before taking on more debt, consider whether you can afford it, if lenders will approve you for a loan, and how the new debt fits into your long-term financial plan.
Can you afford it?
The most important question to ask before taking on more debt when you have debt from student loans is whether you can afford it. But how do you determine what you can afford?
The best way to figure this out is to create a budget and track your spending over several months. The amount you have left over at the end of the month after you pay for all your necessary expenses and your student loan debt could be used, in part, toward a new monthly debt payment.
While lenders may approve borrowers for the maximum they think they can afford, you might not want to borrow that full amount since your personal budget might not have room for that large of a debt obligation. You might also end up struggling to pay your daily expenses and have to resort to credit cards.
Will they lend to you?
Before you start picking out the color of the car you hope to finance, you need to know whether lenders will give you the money to buy it, despite your debt from student loans. How do lenders decide whether to give you a loan?
When you apply for a loan (e.g., auto, mortgage, personal), lenders review your credit score and your ability to make monthly payments, which is measured using a debt-to-income (DTI) ratio. Your DTI could be too high to qualify for some loans if you have student loan debt. It is calculated by dividing your monthly debt obligations against your gross income. For example, mortgage lenders won't extend you a mortgage if the amount you'll have to pay each month, in addition to the amount you pay toward debt already, is more than 43% of your gross income.
There are ways to change your debt-to-income ratio if it is too high because of your student loan debt. One strategy is to earn more income, which you could do by applying for a better paying job, or taking on a side hustle. You can also pay off existing debt or refinance your student loan debt to reduce your total monthly debt payments. If you extend the length of your loan term, however, you could pay more in interest over the life of the loan.
Finally, you'll want to improve your credit score. The good news is that just having student loans might have already helped you do this. If you've paid your loans on time, you'll likely have increased your credit score. The following actions may help you improve your credit score:
- Paying your debts on time
- Using less than 30% of your available credit
- Diversifying the types of credit you have
- Limiting how many times you apply for new credit
Improving your credit score will eventually help you qualify to borrow more money (say, for a home) and help you get a lower interest rate, which will save you money. However, refinancing your debt could cause your credit score to dip a little since you'll be making a hard credit inquiry, something which causes you to lose points.
Does it fit in your financial plan?
If you don't have a financial plan, you should. When you have student loans, your finances can be more stretched than someone who has already repaid their loans or never had any to begin with, because you need to make a payment every month. Having clear financial goals helps you decide whether it makes sense to take on more debt, what to put toward savings and retirement, and how to pay off your debt from student loans.
While you can create a financial plan with a professional financial planner, you can also use online resources to help you create one on your own. Knowing what you want to do with your life and your money will help you make decisions about whether to take on debt in addition to student loan debt.
Fewer regrets later
While you might want to borrow money to replace your old car with a newer model or to buy a new condo, being cautious and thinking through your choices—especially if you already have student loan debt—can help you make an informed decision.