Do you have a steady job? Do you have a good grasp on your everyday expenses? You might think it’s a good time to buy a home. But wait – should you really buy a home if you still have student loan debt?
We’ll take a look at how student loan debt might affect your ability to get a mortgage. We’ll show you how lenders view this kind of debt and give you some tips to improve your chances of qualifying.
Overview: How To Get A Mortgage
Before we talk about how debt affects your ability to get a mortgage, let’s go over the process you’ll go through to get a loan.
The first step is to get a preapproval. A preapproval letter is a document that indicates you’re a good candidate for a mortgage based on the information you’ve given the lender. Your lender will ask you for some financial documentation and for permission to view your credit report. This will tell the lender about your current student loan balance.
Most preapprovals also include a loan amount that you qualify for and an estimate of what your monthly payment might be. It’s important to get a preapproval because it helps you shop for homes within your budget.
Our RateShield™ Approval Letter can give you the strength of a cash buyer, making your offer more attractive to sellers since we verify your credit, income and asset information up front.
Underwriters will look at your:
- Current debt
- Credit score
- Unusual activity in your recent bank account transactions
- Other assets you have
Once all of your documentation is verified and the home appraises at the value necessary, your lender will give you a document called a Closing Disclosure which includes the final terms of your loan and your closing costs. From here, all you need to do is acknowledge your disclosure, attend a closing meeting and sign on your loan.
How Student Loans Are Viewed By Lenders
You don’t need to be 100% debt-free to buy a home or qualify for a mortgage. However, one of the most important things that lenders look at when they consider you for a loan is your current debt, including any associated with your student loan. Lenders need to know that you have enough money to make your payments after you get your loan. The more debt you have, the more likely you are to fall behind on your payments.
Lenders look at a number called your debt-to-income (DTI) ratio when they consider you for a loan. Your DTI ratio describes the percentage of your monthly income that goes toward debt. You may have trouble getting a mortgage if you have a high DTI ratio. Calculating this ratio is simple.
First, add together all of the monthly payments you make. Only include regular, recurring and required payments in your calculations. Some payments you should include in your DTI calculation include:
- Your monthly mortgage payment or rent
- Your homeowners insurance or renters insurance premium
- Any monthly homeowners association fees you pay on your current property
- Minimum credit card payments
- Student loan payments
- Auto loan payments
- Personal loan payments
- Court-ordered back taxes, alimony or child support payments
Leave out expenses that vary from month to month. Some expenses that you shouldn’t include in your DTI ratio calculation include:
- Entertainment, food and clothing costs
- Utility bills
- Transportation costs
- Savings account contributions
- 401(k) or IRA account contributions
- Health insurance expenses
Remember to only include the minimum required payment you need to make each month. If you have $20,000 in student loan debt but you only have a minimum required payment of $100 a month, only include $100 in your DTI ratio calculation.
Add all your monthly recurring expenses, then divide the number you get by your total pre-tax monthly income. Is someone else applying on your loan with you? If so, include their income in your calculation as well. Multiply the number you get by 100 to get your DTI ratio as a percentage.
Let’s take a look at an example. Imagine that you have a total monthly gross income of $4,000. Say that you have the following monthly debts:
- Rent: $500
- Student loan minimum payment: $150
- Auto loan minimum payment: $250
- Credit card minimum payment: $100
In this example, you’d first add up all of your debts for a total of $1,000. Then divide $1,000 by your total gross income, $4,000. Your DTI ratio is 0.25, or 25%.
Take a look at how your current student loan debt compares to your overall income. Though the specific DTI ratio you need for a loan depends on your loan type, most lenders like to see DTI ratios of 50% or lower. You may need to work on reducing your debt before you buy a home if your DTI ratio is higher than 50%.
Should You Pay Down Your Student Loans Before Buying A House?
So should you pay off your student loans before you buy a home? First, take a look at your DTI ratio. Lenders care less about the dollar amount of debt that you have and more about how that debt compares to your total income. You can still buy a home with student debt if you have a solid, reliable income and a handle on your payments. However, unreliable income or payments may make up a large amount of your total monthly budget and you might have trouble finding a loan. Focus on paying down your loans before you buy a home if your DTI is more than 50%.
Look at other areas of your finances before you consider homeownership. You may want to hold off until you build up a fund if you have a reasonable DTI ratio but you don’t have an emergency fund. In the same vein, if your student loan payment is standing in the way of retirement contributions, wait to buy a home until you pay down more of your debt.
Finally, look at your interest rate. If you have a high interest rate on your student loans, your loans will cost more over time. Pay down more of your loans before you invest in a home to limit what you pay in interest. Also, take a look at your repayment plan and compare your monthly payments to your accruing interest. If your payments are low but you aren’t paying off at least your accruing interest every month, you’re actually going deeper into debt. In this situation, you should pay more than your minimum and focus on paying off your loans first before you take on more debt with a mortgage.
It might be time to buy a home if you have an emergency fund, your DTI is low, you’re contributing to your retirement and you’re on a solid repayment plan.
Actions You Can Take To Help You Qualify
Set on buying a home even though you have student loans? Here are a few steps that you can take to improve your chances of qualifying.
Consider All Loan Types
You may not qualify for a conventional loan if you have a DTI ratio that’s higher than 50%. A conventional loan is a loan not formally backed by any government entity. Instead, a conventional loan follows guidelines set by Fannie Mae and Freddie Mac, which standardize mortgage lending in the U.S.However, you may still be able to buy a home with a government-backed loan. These loans are insured by the federal government, which makes them less risky for lenders. This allows mortgage lenders to issue loans to borrowers with lower DTI ratios.
You could also consider an FHA loan, which is backed by the Federal Housing Administration. The maximum DTI ratio for an FHA loan is 57% in many cases. On the other hand, if you’ve served in the armed forces or National Guard, you may also consider a VA loan. You can buy a home with a DTI ratio of up to 60% with a VA loan. Make sure you meet service requirements before you apply for a VA loan.
Pay Off Another Debt
The fastest way to lower your DTI ratio is to pay down some of your debt. Paying off debt eliminates a recurring expense and frees up more cash flow. Consider paying off another debt source if you can’t afford to make an extra payment on your student loans. For example, you’ll instantly see your DTI ratio fall if you have credit card debt and can pay it off in full.
Increase Your Income
You can also lower your DTI ratio by increasing your income. Pick up a few more hours at work or take on a side hustle so you get the cash injection you need. Keep in mind that you’ll need to prove that this extra income is regular and recurring for it to count toward your DTI ratio. Most lenders want to see at least a two-year history for all of your income sources.
You don’t need to be debt-free to buy a home, but you may have trouble getting a loan if you have too much debt. Calculate your DTI ratio and compare your monthly debts to your gross income. Pay down more of your debt before you buy a home if your DTI ratio is higher than 50%.
Also, make sure your financial situation is stable before you invest in a home. You might want to be sure you’re on a solid repayment plan, have an emergency fund and are contributing toward retirement before you shop for a loan. You may also want to increase your income or lower your debt before you apply for a loan. You might also be able to get a mortgage with a high DTI ratio if you choose a government-backed loan.
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