Any debt is a potential obstacle to homeownership, but there’s one type that has some unique challenges: student loan debt.
Student loans are complicated, but if you know how they affect your financial profile, they don’t have to hinder your homeownership plans. “What we have to consider is how does the monthly student loan payment impact how much we can afford,” says Kyle Seagraves, certified mortgage advisor with the homebuyer education site and YouTube channel Win The House You Love.
On the surface, this seems like a simple calculation. A $400-a-month student loan payment would reduce the monthly mortgage payment you could afford by $400. But student loans offer a number of payment options other forms of debt don’t.
How you qualify for a mortgage changes if you’re taking advantage of student loan forbearance, deferment, or income-based repayment. And to add to the complexity, the way these situations are looked at changes depending on the type of mortgage loan you’re applying for. So student loans can limit not only how much house you can afford, but also influence what type of mortgage is best for your situation.
If you’re on an income-based repayment plan, look into conventional loans because your lower monthly payments may help you qualify for a mortgage.
But if you understand the rules, you can minimize the effect student loans have on your housing options. Here’s what you need to know.
How Student Loans Affect Your Home Buying Choices
In many ways, student loans have the same impact on the home buying process as other types of debt. Because you owe money, you’ll be able to borrow less and it makes it more difficult to save up enough to make a down payment or to pay for closing costs.
But because of the variety of repayment options and types of loans, there are extra things you’ll need to consider when it comes to student debt.
Increased debt-to-income ratio
Your debt-to-ratio (DTI) is a calculation of the debt you owe compared to your gross income. Lenders are mainly concerned with what is known as your back-end DTI, which is used to determine how much they’re willing to let you borrow. “DTI is, in my mind, the biggest number, outside of credit score, that is used when qualifying somebody for a loan,” Seagraves says.
Your back-end DTI includes your existing monthly debt payments and your future mortgage payment. So if you make $5,000 a month, and all of your monthly debt payments plus your future mortgage payments total $2,000, your DTI is 40%. Here’s how that’s calculated:
2,000 ÷ 5,000 = 0.4 (40%)
The maximum DTI you’re allowed to have varies depending on the mortgage, but “… a good rule of thumb is 45%,” Seagraves says. However, that doesn’t necessarily mean it’s a good financial move to borrow as much as a lender is willing to give you. “A lender is not mainly concerned with a buyer’s financial health, what it’s concerned about is getting its money back,” Seagraves says. So he recommends that your monthly debt doesn’t exceed 25% to 30% of your monthly take-home pay, which isn’t just a lower number, but also factors taxes into the equation.
If you’re currently repaying your student loans, calculating DTI is simple. You’ll just add in your monthly student loan payments. But things get confusing if you’re taking advantage of student loan forbearance, deferment, or an income-based repayment plan (IBR). “The status of your student loan affects how [lenders] calculate your student loan payment in that debt-to-income ratio,” says Catalina Kaiyoorawongs, co-founder of the student debt financial wellness platform LoanSense.
An IBR isn’t a permanent adjustment to your student loan payment. Since you’ll need to re-qualify for IBR, and the payment amount can change, your DTI is calculated differently depending on the mortgage.
Below is a table showing how your DTI is calculated depending on the type of mortgage. There are niche situations where the rules vary. So use this only as a guideline and always ask your lender about your situation.
|Loan Type||Usually, if You’re Not Making Your Regular Payments, Then DTI includes…|
|Fannie Mae (Conventional Loan)||1% of loan balance, zero dollar IBR monthly payments are allowed|
|Freddie Mac (Conventional Loan)||0.5% of loan balance, IBR monthly payments can be used if greater than zero dollars|
|FHA Loan||1% of loan balance|
|USDA Loan||0.5% of loan balance|
|VA Loan*||5% of loan balance divided by 12|
Harder to save for a home
Between the down payment and closing costs, the average homebuyer needs to come up with tens of thousands of dollars for these upfront costs. On top of that, you’ll have other expenses, such as moving costs and building an emergency fund to cover unexpected repairs. Student loan debt makes this part of the homebuying process even harder.
A 2017 Federal Reserve study showed that for every $1,000 in student loan debt, homeownership was delayed by an average of 2.5 months. So it’s having a big impact on when borrowers are able to afford a home.
Potential impact on your credit score and approval chances
Student loans will appear on your credit reports and impact your credit score. If you miss payments or make late payments, that will have a negative impact on your credit score. A lower credit score not only makes it harder to get approved for a mortgage, but can also increase the mortgage rate you qualify for.
How missed payments are treated is different depending on if you have private or federal student loans. “With private loans, if you miss a payment or you miss several and you’re put into collections, then they’re going to be treated just like any other late payment or collections account,” Seagraves says. “But when we get into defaults or missed payments on government student loans, that’s when things get really tough.”
The U.S. Department of Housing and Urban Development (HUD) maintains a database of all Federal debt, known as the Credit Alert Verification Reporting System (CAIVRS). If you’re delinquent on any Federal debt, such as Federal student loans, it’ll appear in this database. And you’re unlikely to be approved for any government-backed loan until you make up for the missing payments and are back into a repayment plan.
How to Qualify for a Mortgage With Student Loans
Getting a mortgage while you have student debt may be tougher than if you didn’t have any debt, but there are steps you can take to increase your chances.
The most important thing to do is to make sure your loan payments are current. Paying your student loans on time will help to increase your credit score over the long haul.
And there are ways you can minimize the impact student loans have on your DTI and your ability to save up to buy a house.
Decrease your DTI by getting into repayment
If you’re currently not in active repayment for your student loans, that can have a big impact on your DTI. This is especially true if you have a high loan balance.
Let’s say you have $80,000 in student loans and are applying for an FHA loan. If you’re in forbearance, your DTI calculation will include 1% of your student loan balance, or $800 a month. However, you may have repayment options that are significantly less than $800 a month. “If we just took [the borrower] out of a paused payment and put them into repayment, they could actually use federal programs to reduce their payment and now qualify [for a mortgage], based on a lower active payment,” Kaiyoorawongs says.
So if you’re currently taking advantage of the universal federal student loan forbearance, but can afford not to, you may be able to lower your DTI by entering repayment. However, you can’t just start making student loan payments and have that amount count toward your DTI, even though your lender will gladly accept your money. “To get into repayment, you actually have to file paperwork,” Kaiyoorawongs says.
Take advantage of homebuyer-assistance programs
Saving up enough money for a down payment is a big obstacle to becoming a homeowner, regardless of whether you have student loans.
Monitoring your spending and savings with a useful budget is important, but you may also qualify for assistance. There are thousands of down payment assistance and first-time homebuyer programs throughout the country. These programs offer thousands of dollars in support through grants, forgivable loans, or no- to low-interest loans.
What programs are available varies widely depending on what state or city you’re purchasing in. So it’s important to connect with a knowledgeable local real estate professional or housing counselor who can help you understand what options are available to you. Also, while many of these programs are designed for first-time home buyers, you’ll typically qualify as a first-time buyer as long as you haven’t owned a home within the last three years.
Take advantage of existing student loan forgiveness programs
In recent years, the calls for student loan forgiveness have been growing louder. But there is currently no concrete plan forgiveness in the near term. However, there are a handful of existing student loan forgiveness programs available, if you qualify.
These programs offer full or partial forgiveness based on qualifying criteria, such as your job or how many payments you have made. You may qualify for forgiveness or other student loan debt relief as a teacher, government or non-profit employee, military veteran, or if you work in the medical field.
Keep in mind, that these programs typically apply only to federal student loans, not to any student debt that is held by private lenders. They also can have strict guidelines. For example, to qualify for public service student loan forgiveness you must have made 120 qualified payments while working full-time for a qualified employer.
Student debt is a problem. “What’s happening is it’s making people feel demoralized. I got this education, and now it’s impeding me from my future goals, like buying a house, and they feel wronged by the system,” Kaiyoorawongs says.
But your student loans don’t have to be an insurmountable obstacle. There are ways to limit its impact on your ability to borrow. And if you can take advantage of first-time homebuyer programs, or low down payment loans, you may not need to save as much as you might think in order to be able to purchase a home.