A finding from a recent report by the National Association of Realtors shows that fully half of the people who haven’t yet purchased a home blame their student debt. Millennials (the term used to group those born between 1981 and 1996) were the most likely (60%) to say that their student debt was making them put off homeownership.
Outstanding student loan debt in the U.S. has surpassed $1.7 trillion and is causing more financial burdens on Americans than credit card and auto debt. Additionally, around a third of student loan borrowers are in delinquency or default.*
Many people think that student loan debt & mortgages can’t co-exist. But, despite the challenges of student debt, experts say it’s still possible for borrowers to become homeowners. But how do your education loans affect your eligibility for a mortgage, and how can you find workarounds?
Factor 1: Your Debt to Income Ratio
Your Debt to Income Ratio (DTI) is calculated by adding up all your monthly debt payments (including your anticipated mortgage payment) and dividing the total by your gross monthly income. Debt payments include student loans, mortgages, rent payments, auto loans, credit card debt and any other installment or revolving debt that you are required to pay.
Lenders generally use the 28/36 rule. This means that no more than 28% of your gross income should go to your mortgage payment, property taxes, and insurance. Also, your total dept payments including the expected mortgage payment should be no more than 36% of your gross income. Some loan programs such as FHA loans will qualify borrowers with DTIs of up to 43%.
To lower your DTI there are several options you can use to reduce, consolidate, or defer your monthly student loan payments.
- Switch to a graduated repayment plan. With these plans, payments start low then rise every two years as your income level increases.
- Request to lengthen your term. The longer term will reduce the amount you owe each month. You’ll pay more interest in the long run but it will reduce your DTI in the meantime.
- Consolidate different student loans at a lower interest rate. This will reduce your payments and package them together in one convenient monthly payment.
Factor 2: Your Credit Score
Your loan payment history will impact your credit score. If you fall behind on your monthly bills you can expect your score to drop. If this happens it can reduce your likelihood of loan approval and/or increase the interest rate you will pay. Unlike credit card debt, student loan debt is an installment loan in which you’re required to pay a fixed amount each month. Owning a large amount in an installment debt won’t hurt your credit score like a large amount of credit card debt would.
The lesson here: pay your loan on time each month to help build your credit profile.
Factor 3: Your Income and Down Payment
Another thing you will need to consider is your debt to loan (DTL) ratio. Your DTL is the ratio of the amount of your loan in relation to your total debt. If your loan amount is too high, your monthly payment will be higher which will affect your DTI.
If your debt-to-loan ratio is too high, you could offset that ratio by saving for a higher down payment. This will reduce the amount you have to finance and will give you a lower monthly payment. This in turn changes your debt-to-income ratio.
If you’re unable to save for a large down payment, talk to your lender about any down payment assistant programs you might qualify for.
A higher income will also help offset your DTI. Consider negotiating for a raise or starting a side hustle.
Another option to consider is applying for a mortgage with another person. Your spouse or a significant other, family member or friend may be a choice for you.
The Bottom Line
Although it can be challenging to qualify for a mortgage with student loan debt, it isn’t impossible. It’s important to know where you stand and focus on the steps you need to take to reach your goal. In the end it will be well worth the effort.
Contact the Donnelly Group
We’ll admit, this can all be pretty complicated! If you are considering buying a home in metro Phoenix, but don’t know where to start when it comes to the ‘student loan debt & mortgages’ equation, the Donnelly Group has the expertise and the partners to help you.