How Your Student Loans Affect Getting a Mortgage When Buying a Home

The decision to balance student loan debt with homeownership is an audacious one, and quite satisfying if it’s well-executed. Find out how your degree type and student loan repayment program influence your ability to secure different types of home loans – and learn what you need to do to demonstrate your capability as a borrower.

Purchasing your first home is a huge investment, and an even greater accomplishment. To ensure your success, it’s imperative to have your finances in order. In particular, there may be much speculation and concern surrounding the impact of student loan debt on home-buying achievement. Perhaps you’re wondering how much your loan payment obligations will interfere with your mortgage responsibilities. It’s quite possible you’ve already struggled to save for your down payment because your student loan debt got in the way.

How will these issues continue to collide for years to come?

The Influence of the Degree

Good news. Research from Zillow indicates that your student loan debt shouldn’t be too much of a pain point when it comes to homeownership. The caveat is in the type of degree you have.

  • Bachelor’s Degree: People with four-year degrees and no student loan obligations are ideally-suited to purchase homes. The probably of ownership for graduates who owe roughly $50,000 is essentially the same, however. Your odds of affording a mortgage aren’t much lower if you are married.
  • Graduate Degree: Medical, law, and other graduate schools are notoriously expensive. Still, earning a high-level degree puts you in prime position for homeownership.
  • Associates Degree: This is where things get complicated. If you graduate with a two-year degree and about $50,000 in student loan debt, your chances of purchasing a home are under 60 percent. If you accumulated the debt without actually earning a diploma, that probably dips below 50 percent.

Of course, there are numerous other factors that play into your chances of securing a mortgage. The debt-to-ratio is dynamic, and the different types of mortgage loans even factor into the equation.

Mortgage Lending and Repayment Options

The negative impact of student loan debt on home buying may not be much more damaging than other types of debt, such as car loans and credit card balances – but it does still play a substantial role in the process. Millennials in particular understand this burden, because they feel more pressure to earn college degrees more than any other generation has.

When assessing favorability for a mortgage loan, the lender will consider points such as your income and employment history, your assets, your credit score – and your monthly debts. You may have known this fact, but did you know the dollar amount or percentage of your student loan payments that is required to be included in the calculations varies based on the type of mortgage you’re hoping to receive?

Many – if not most – student loans are supported by federal agencies. That means securing a government-backed mortgage might be challenging. This is especially true if you haven’t been consistent in your loan payments. Fortunately, there are several types of student loan repayment plans, so it is quite possible to find one that works well for you. Each of these options, from income-sensitive and extended repayment plans to income-driven and graduated repayment plans, influences mortgage eligibility differently.

The next step of the journey is to explore the types of home loans and consider how student loan debt fits into the puzzle.

  • United States Department of Agriculture (USDA) Loans: Lenders in these cases typically do not entertain income-based, deferred, or graduated student loan repayment options. They are likely to require fixed payment plans, or consider one percent of the loan balance as the monthly payment. This can be detrimental to loan eligibility; a $40,000 loan, for instance, will be translated into a $400 monthly payment expectation!
  • Veterans Administration (VA) Loans: If you must make a student loan payment within a year of closing on your new home, the debt must be included in the equation. If your loans are in deferment or forbearance, they must also be considered in the debt-to-income ratio. If you’ve been in deferment status for at least three years, however, your debt may be calculated as zero in this specific case. At any rate, be prepared with plenty of documentation. If you can’t produce any, the lender will either calculate five percent of the loan balance and divide it by 12, or simply refer to the obligation listed on your credit report.
  • Federal Housing Administration (FHA) Loans: FHA loans are popular options among first-time buyers. For this reason, you can expect strict guidelines. No matter what the amount or status of your student loan payment is, the lender will use one percent of the overall balance to calculate your debt-to-income ratio.
  • Standard Loans: There are always traditional loans to consider. The requirements are relatively flexible. You’ll need to provide thorough documentation, of course, and your loan provider will also be asked to so the same. The monthly payment listed on your credit report will be used for your debt-to-income ratio. If your debt is in deferment status, one percent of the balance will be used.

Diving Deeper: How Does It All Add Up?

When assessing you, lenders focus on front-end and back-end debt-to-income ratios.

Now that you understand the most commonly-used mortgage options and how they relate to student loan debt, it’s crucial to learn what other matters are considered when determining eligibility. When assessing if you are able to fit a mortgage payment into your budget, lenders focus on front-end and back-end debt-to-income ratios.

To figure out your front-end ratio, it is necessary to divide the estimated monthly payments by gross income (also monthly). Taxes, interest, and principal are all included in these estimated payments. Many lenders require that the ratios fall between 28 and 36.

Your debt, which includes your outstanding student loan balances, car loan payments, minimum credit card expectations, and child support obligations, factor into your back-end ratio. The total of your monthly amount owed is divided by gross income (again, monthly). It’s best if this ratio falls under 36, and don’t expect much if it is over 41. In that case, your only hope is to have a stellar credit score or have a sizable down-payment to offer.

How to Put Yourself in Prime Position for Homeownership

Despite all the requirements and the work it takes to meet them, landing a mortgage loan is far from impossible. With the right strategy and thorough preparation, you can continue on the path to homeownership. Here are some suggestions to help you along:

  • Plan: Start saving for your down payment at least a year in advance of the time you hope to make the purchase. Obviously, the more you have to offer, the better. If you can, seek a raise at work, a higher-paying job, or even a side job.
  • Minimize Debt: You probably can’t pay off your student loan balance – or any other debt you have – entirely, but you can vastly decrease your debt. Perhaps you can pay off smaller credit card balances, for example, and make a substantial dent in your auto loan. Make sure to avoid accruing new debt at any point in the process.
  • Reduce Your Living Expenses: Hold off on your next vacation, and consider cancelling that big cable package. You would also do well to eat out less and take energy-saving measures to keep your utility bills low.
  • Boost Your Credit Score: Your credit-worthiness is probably the biggest factor a mortgage lender will consider when deciding whether to offer you any money, so keep a keen eye on your score. Make sure all your bills are paid in a timely manner. If you have old credit accounts that are in good standing, keep them open even if you don’t use them any longer. A mix of installment loans (like your student loans) and revolving credit (such as credit cards) is a good thing.
  • Explore Down Payment Assistance: There are many state and regional programs out there to help you pull together a down payment. Some federal programs are lenient with down payment requirements as well. The FHA expects under four percent of the price of the home, and the USDA expects no down payment at all. Also keep in mind that a loan cannot be used as a down payment, but a monetary gift from friends or family members is acceptable.

Finally, know that it is always best to get pre-approved for your loan, because sellers will look more favorably upon you as a buyer and you will know exactly what your limitations are in terms of your new home. Seek the services of a reputable mortgage consultant to help you navigate the system.

Moving Forward

Purchasing a new home is a huge life milestone, and debt impedes the process for many people. Your student loans won’t necessarily prevent you from becoming a homeowner, but they won’t help. You must be prepared to carry the load of at least two substantial debts.

With the right planning and insight regarding the opportunities and repercussions, however, there is no reason to allow student loan debt to get in your way.

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