If you want to buy a home but are still saddled with student loan debt, you are definitely in good company!
Nationwide, current research indicates more than 44 million Americans are carrying student loan debt in amounts ranging from $37,000 to $40,000 or more.
What does this mean for your dreams of home ownership in the near future, you may be wondering. According to the Federal Reserve, for every $1,000 increase in the amount of your student loan debt, you have a one to two percent decreased chance of owning your own home.
After working so hard to finish school, begin your career and launch into your adult life in earnest, this can be a tough and bitter pill to swallow. But just because this is the case for many debtors who are aspiring homeowners doesn’t necessarily mean it will apply in your unique situation.
In this article, find out what you need to know about student loan debt when buying homes.
Do You Have to Postpone Buying Your Home?
The answer to this question is not one-size-fits-all by any means. A lot depends on your own personal financial history as well as how comfortable you are with bearing additional debt.
Any financial institution you approach for mortgage financing is going to be keenly interested in your personal financial history, which means you should be too – and start looking at it before a potential lender does!
With some flexibility and creativity, it may be possible to convince a mortgage lender to approve a new home loan.
Areas where you may need to challenge yourself to become more flexible include these:
- Settling for the amount of home you can truly afford (or qualify to afford) and then use that as an equity-building stepping stone towards the home you really want.
- Opting for a more affordable townhouse or condo until you can qualify for the type of home you truly want.
- Look for owner-financed homes where mortgage terms may be more favorable to your situation.
- Finding a willing co-signor, such as a relative, that the lender will accept.
What Can You Do to Secure Home Financing Even with Student Loan Debt?
Rather than assuming your student loan is an insurmountable obstacle to owning your own home, it is important to know that there are practical steps you can take to improve your chances of securing financing.
There are three “keys” if you will to successfully securing a mortgage loan.
Your credit report is initial gatekeeper when you apply for mortgage lending as a first-time home buyer.
So you will want to devote some time to requesting copies of your credit report from all three credit reporting bureaus, Experian, Equifax and Transunion (this because each bureau may report on different credit-related events).
Notice any discrepancies or errors and contact the reporting bureau to resolve them as quickly as possible. Then request a fresh copy of your credit report to be sure the issues have been resolved.
Do this before you make your initial application for a mortgage loan to be sure your credit score is as high as it can possibly be.
DTI (debt to income ratio)
If your credit score is sufficiently favorable to get you past the front gate in your loan application, the next step will involve calculating your DTI, or debt to income ratio.
The DTI is where many aspiring home buyers who carry too much debt, whether student loan-related or otherwise, find that they have stalled out. Most mortgage lenders want to see a DTI of between 28 and 36 percent depending on each applicant’s situation.
There are two measurements mortgage lenders use to evaluate an applicant’s DTI. The first is called front-end DTI and the second is called back-end DTI.
Your front-end DTI is the percentage of your gross income (income before expenses) that goes directly towards paying for your lodging. This includes mortgage, insurance, homeowner’s fees and relevant costs. Here, most lenders want to see your front-end DTI at 28 percent or lower.
Your back-end DTI is the percentage of your gross income that goes towards current debt repayment, whether your particular debt happens to be in the form of student loans, credit card balances or something else. Here, out lenders want to see a back-end DTI of 36 percent or lower.
However, the Consumer Financial Protection Bureau (CFPB) reports that the DTI ceiling for a qualified mortgage is currently set at 43 percent. So if you are comfortable with a higher level of debt and confident you can repay and your credit score and all other financial data supports this, you may still be able to qualify for a mortgage.
Certain government-sponsored home buying programs, such as those offered under the Veteran’s Administration (VA) or the USDA home buying program, allow for a zero down payment.
For other types of mortgage lending, however, the amount you plan to put down as a downpayment will impact both whether you can qualify for funding and how much you will pay for that funding.
How Can You Calculate Your DTI in Advance?
Fortunately, you can do your own initial calculations to figure out your DTI before you ever talk with a mortgage lender.
For simplicity’s sake, let’s say your monthly gross income is $5,000.
The home you want to buy would cost you $1,500 per month for mortgage repayment and $150 for home insurance. $1,650 divided by $5,000 is 0.33. So your front-end DTI is 33 percent. You are still within the 28 to 36 percent DTI window.
But then let’s say you are also paying off your student loan debt at a rate of $200 per month and a credit card balance at a rate of $100 per month, adding $300 to your total debt burden.
Dividing $1,950 by $5,000 now delivers a 0.39 DTI – a DTI of 39 percent. This puts you outside the desirable DTI window of 28 to 36 percent, but still below the qualified mortgage limit of 43 percent.
What will a mortgage lender do with these numbers? It can be hard to predict without factoring in both your credit score and your proposed downpayment.
Can You Lower Your DTI to Qualify for Funding?
If you are planning to refinance your student loans in order to try to lower your DTI and qualify for mortgage funding, the timing of when you do this really matters.
Enter into a refinancing agreement too close to when you plan to apply for mortgage funding or when your application is pending and your loan might be denied.
It is also important to be aware of the downside of refinancing your student note with a private lender.
You still have no guarantee your mortgage application will be approved and in the meantime you will forfeit certain student loan benefits that can help you out if you fall on financial hard times.
Are There Other Possible Options to Afford a Home With Student Loan Debt?
The Fannie Mae Home Ready Program provides mortgage lending to prospective home buyers with student loans. This service permits a DTI of 50 percent as long as you can pay at least three percent down payment on your new home.
The Federal Housing Administration (FHA) loan program will permit a DTI of up to 43 percent with a 3.5 percent downpayment and a credit score of 580 or higher (or a 10 percent downpayment for lower scores).
Doing careful research into different types of mortgage funding, talking with your accountant about debt refinancing, increasing your credit score and planning ahead to afford a down payment can all help you afford a new home even with student loan debt. (Related: Must Have Tools for New Homeowners)