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?
"It's very important to carefully consider taking on more debt because debt obligations last years, not months," says Kyle Kroeger, the founder of the personal finance blog Millionaire Mob. "Extra debt can change your lifestyle and sometimes your life."
For that reason, Kroeger suggests that before adding to your debt burden, you take the time to consider things like 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?
Lou Haverty, a certified financial advisor and the founder of Financial Analysis Insider, believes that 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, towards a new monthly debt payment.
"You could take your leftover income after expenses and say 50 percent could be available for a monthly debt payment and the other 50 percent would go to savings so you'll be covered if your future expenses are higher in a given month," he says. "These percentages could vary slightly based on your personal situation, but it's a good starting point for thinking about what you could afford as a monthly 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.
"If you're not able to handle the new debt payments,"Haverty says, "it can lead into a spiral of funding your monthly expenses with high interest credit."
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 actually give you the money to buy it, despite your debt from student loans. How do lenders decide whether to give you a loan?
Haverty explains that the process may be different depending on what type of credit you're trying to access.
"In the case of a mortgage, the lender will look at your credit score, but will also take a closer look at your ability to meet the monthly mortgage payments, which is measured using a debt-to-income ratio."
Your debt-to-income ratio 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. Generally, 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 percent 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 to reduce your total monthly debt payments.
However, the easiest way to change your ratio might be to reduce the cost of your monthly loan payments — something you could do by refinancing your student loan debt or refinancing other debt at a lower interest rate or over a longer term, says Haverty. 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.
- Paying your debts on time
- Using less than 30 percent 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.
"Your credit score is extremely important in determining how affordable your loan will be in terms of your interest rate and other terms and how quickly you can borrow," says Kroeger. "Having an outstanding credit score can save you thousands."
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.
"The decisions you make in regards to spending habits, investment, savings and retirement plans significantly affect your financial position over the long term," says Kroeger.
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 or not 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.
"By considering your personal financial situation before taking on additional debt, you are positioning yourself to be a much more successful borrower," says Haverty.