by Megan Wild
If you’re one of the growing number of young people with high levels of student debt, you may be worried buying a home is out of reach for you. More than 50 percent of student loan borrowers say the amount of their debt affects their ability to purchase a home.
It’s certainly possible to buy a home when you have student debt. People do it every day! But it is true you need to be savvy about how you approach buying a home.
Here are the steps to navigate home buying when you have student loan debt.
Know Your Debt-to-Income Ratio
Lenders scrutinize the earnings of all home loan borrowers. They must be certain borrowers will be able to make the monthly mortgage payments.
One of the key metrics they rely on is the debt-to-income (DTI) ratio. You should know this before you can think about getting a home loan.
The DTI is precisely what it sounds like. It’s what you pay on total debt each month, including the prospective mortgage. Lenders calculate the mortgage payment, plus student loan, credit card, car and any other loan or obligation service each month, divided by your monthly gross income.
Lenders like to see housing payments of 28 percent or less, and a total DTI of 36 percent or less. So if your gross monthly income is $4,000 and you pay $1,000 per month currently in rent, your housing costs are 25 percent of your gross income. That will make most lenders happy, since it’s less than 28 percent.
If you pay $200 on a student loan each month, plus $100 on a credit card in addition to $1,000 on rent, your total DTI is 32.5 percent. This DTI will also be low enough for you to get a mortgage.
But if you pay $200 on your student loan, $100 on a credit card and $200 on a car loan, your total monthly debt service is $500, in addition to the $1,000 in rent. At that point, your DTI is 37.5 percent. You may have difficulty obtaining a mortgage until you get it down to 36 percent.
Some lenders will approve mortgages if the DTI is as high as 43 percent. The interest rates or other costs, however, are likely to be higher. Also, you need to think long and hard about whether your payments will be sustainable. Spending 43 percent of your income on total debt service does not leave much income after taxes.
However, once you know your DTI, it is possible to improve it by reducing your monthly debt service, paying off debt or raising your income.
Reduce Your Monthly Debt Service
One of the best things you can do is to reduce your monthly debt service.
There are several methods of reducing your student loan debt. You can refinance it. You can apply for an income-based repayment plan, which lowers total monthly repayment costs for many people. You can consolidate your student loans, if you have more than one. Consolidation also lowers payments for many people.
If you have car loans, credit card debt or other loans, make every effort to reduce these as well.
Know Your Credit Score
Lenders use credit scores to determine your credit history and whether you are a good credit risk. A good or excellent score will likely result in mortgage approval. If you find you have an average or poor credit score, though, you may have difficulty getting approved. That’s why you want to be sure of your credit score first.
Your credit score is calculated using several measures. One is whether you’ve paid bills on time. Make sure you do! Your credit score also reflects the total amount of debt versus credit you have available, the length of time you’ve had credit and several other factors.
If you need to improve your score, look at which category is affecting it negatively and work to improve it. If you haven’t made all your loan payments on time, for example, start now.
Save for a Down Payment
Many lenders require a 20 percent down payment to approve a mortgage. Some, such as lenders that offer mortgages through the Federal Housing Administration (FHA), will require much less. FHA loans require a down payment as low as 3.5 percent.
Be aware, though, that you need to have a student loan payment plan in place when you apply for an FHA loan. They will calculate what you’re paying if you have an income-based repayment plan in place, for example. But if you are deferring payments, they will estimate payments at 2 percent of the total. If you owe $50,000 in student loans, that’s $1,000 per month. It may end up disqualifying you because of estimated high payments.
Calculate How Much You’ll Need at Closing
Be aware, down payments and mortgage payments are not all you’ll need to purchase a house. You will also need closing costs. Closing costs can include, but are not limited to, points — a percentage of your loan amount — surveying fees, title insurance, attorney fees, recording fees, loan origination fees, private mortgage insurance and property taxes.
Don’t be daunted if you have student loan debt and want a mortgage. Lenders approve people with student debt for mortgages every day. But you do need to navigate the process successfully by following these steps.
Are you looking for a mortgage broker? Check out our Triangle Home Services Directory!