While student loan debt can make it harder to qualify for a mortgage, that isn’t necessarily the case for every student loan borrower.
Keep reading to learn more about buying a home when you have student loan debt and how to make the process easier.
How Student Loan Debt Might Affect Buying a Home
Student loan debt isn’t singled out by mortgage lenders, but when someone applies for a mortgage, all of their debt is taken into account when the lender decides whether or not to loan them money and what rates or terms to offer — particularly when it comes to their DTI, or debt-to-income ratio.
More on that in a minute.
Does the Government Have a Student Loan Home Buying Program?
The government doesn’t have a home buying program whose goal is to help people with student loans secure a mortgage, but it does have programs designed to help first-time and repeat homebuyers buy a single-family home, condo, or other primary dwellings, which may be a good fit for borrowers with student loan debt.
FHA loans (guaranteed by the U.S. Federal Housing Administration) are the best known. Applicants with a minimum 580 FICO® credit score qualify for the 3.5% down payment advantage; someone with a 500 to 580 score might be able to get an FHA loan with 10% down.
Lenders of VA loans (backed by the Department of Veterans Affairs or, in the case of Native American Direct Loans, issued directly) and USDA loans (backed or issued by the Department of Agriculture) often accept lower credit scores than would be required for a conventional mortgage.
VA loans usually require no down payment, and USDA loans never do.
Do Student Loans Affect Your Credit Scores?
When it comes to student loan debt and buying a home, what matters more during the mortgage application process than having student loans is a potential borrower’s credit score.
Credit scores, usually from 300 to 850, are made up of factors such as a history of on-time debt payments, how much debt someone has, and what type of debt it is. Mortgage lenders use FICO scores for applications, with some exceptions.
FICO created different scoring models for Experian, Equifax, and TransUnion, the three main credit reporting bureaus. Mortgage lenders often receive a single report that contains an applicant’s three credit reports and FICO scores.
Student loan debt can help or hurt your credit scores. If you have a history of making on-time payments to your student loans and having them improves your credit mix, that debt could help your credit scores. If you have a history of making late student loan payments, your credit scores can be negatively affected.
Student Loan Debt-to-Income Ratio
Because debt can, clearly, strain a monthly budget, mortgage lenders evaluate the applicant’s DTI ratio. This is one of the factors mortgage lenders take most seriously, as the ratio accounts for how much of your gross monthly income is spent on your debt payments, including student loans.
DTI = monthly debts / gross monthly income x 100
Typically lenders want to see a DTI of 36% or less, though that is not necessarily the maximum.
If your DTI ratio is high and it makes it hard for you to qualify for a mortgage, there are steps you can take to lower your DTI.
Pay Down Your Debts
One straightforward way for aspiring homebuyers to lower their DTI is to pay off more of their student loan debt.
If they can’t pay off the debt in full, they can try to increase their monthly payments or make principal-only payments. Each month as they pay down their debt, their DTI will improve as long as they don’t take on more debt.
Increase Your Income
One way to improve your DTI is to increase your income by applying for a new job, plotting a promotion, or starting a side hustle. An income boost will make the ratio of debt to income smaller.
Increasing your income can serve a second purpose: You can put the extra funds toward debt repayment, which also will decrease your DTI.
Recommended: Passive Income Ideas
Refinance Your Student Loans
Refinancing student loans can be appealing if you can get a lower interest rate or a better-fitting repayment term.
When someone refinances a private or federal student loan, they take out a new loan from a private lender and use it to pay off the existing loan. If you can secure a lower interest rate and keep or reduce the term, you will spend less on total interest and put more money each month toward principal. It might help to crunch some numbers with a student loan refinancing calculator.
A better interest rate when refinancing is not guaranteed, so it’s worth shopping around for the best deal to see if refinancing is worthwhile. Let’s say you find a good deal but later find a better deal. Can you refinance student loans more than once? Indeed.
It’s important to note that although refinancing a federal student loan into a private one can potentially save the borrower money on interest, the conversion will mean losing access to federal deferment, income-driven repayment programs, and public service loan forgiveness.
Borrowers with federal student loans can consolidate them, but doing so doesn’t save money on interest because the new rate for a Federal Direct Consolidation Loan is simply an average of the loan rates, rounded up to the next one-eighth of a percentage point. Still, the consolidation loan remains eligible for federal benefits.
Income-Based Repayment Plan
A potential homeowner who has federal student loans may choose income-based repayment. Those who enroll tend to have big loan balances and/or lower income.
The four income-driven repayment (IDR) plans base payments on family size and state of residence in addition to income. After 20 or 25 years of payments, borrowers are eligible to have any remaining balance forgiven.
An IDR plan lowers monthly payments, which could free up money to save for a down payment. But the longer loan term may slow down progress toward paying off your debt, so it’s worth thinking about how an IDR plan will affect your DTI ratio over time.
Fannie Mae Guidelines
Lenders often follow Fannie Mae guidelines when deciding whether to approve a conventional home loan, which is one not backed by the federal government and is the most common type of mortgage.
Here are some key guidelines:
• Minimum credit score: 620
• DTI ratio: usually up to 45%
• Income: two years of stable income and employment, with some exceptions
• Down payment minimum: 3%
• Private mortgage insurance: required when down payment is under 20%
The Fannie Mae HomeReady® Mortgage is an option for low-income first-time homebuyers and repeat buyers. The loan has pricing that is better than or equal to standard loan pricing and has lower than standard mortgage insurance coverage requirements.
The Takeaway
Having student loans doesn’t necessarily make it harder to qualify for a mortgage, but borrowers may find that refinancing or paying off their student loans frees up room in their monthly budget, which can make homeownership more accessible.
Student loan borrowers dreaming of buying a house may want to consider student loan refinancing with SoFi.
FAQ
Does student loan debt have a negative impact on buying a home?
Not necessarily, but student loan debt can lower or nix borrowers’ chances of mortgage approval if their DTI ratio is too high, and late student loan payments can ding credit scores.
Is it possible to buy a home with student loan debt?
Yes, it’s quite possible to buy a home with student loan debt, especially if the mortgage applicant’s income is much higher than their monthly debt payments.
Should you pay down your student loans before buying a house?
It’s not necessary to pay down a student loan before trying to buy a house, but doing so can’t hurt. The student loan balance affects a mortgage applicant’s DTI ratio, and any money freed up in the budget can go toward the down payment, closing costs, or future mortgage payments.
Photo credit: iStock/tonefotografia
Student Loan Refinancing
If you are a federal student loan borrower you should take time now to prepare for your payments to restart, including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. (You may pay more interest over the life of the loan if you refinance with an extended term.) Please note that once you refinance federal student loans, you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans, such as the SAVE Plan, or extended repayment plans.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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