If you’ve postponed buying a house because of student loan debt, you’re far from alone. In 2018, a collective 45 million Americans owed over $1.5 trillion in student loans. At the same time, American mortgage debt continued to skyrocket. Many college graduates are wondering whether buying a house with student loan debt is a good idea, and whether it’s even possible.
Weighing Your Options
Buying a house with student loan debt is possible if you follow the right steps and know what you’re taking on. Student loans by themselves will not prevent you from qualifying for a mortgage. However, the effects of student loans on factors like your debt-to-income ratio (DTI) can prevent you from buying a home.
This information is what the bank or lender will use to determine whether or not you’re capable of taking on a mortgage. It can also help you decide for yourself whether you feel financially stable enough to take on the burden or, alternatively, what you can do to prepare to take on a mortgage in the future.
If you’re thinking about applying for a mortgage and you have student loan debt, it’s important to know how the bank will judge your mortgage-worthiness. The bottom-line question your potential lender will ask themselves—and you—is, “Are you able to take on a mortgage payment?” To determine the answer to this question, banks boil down your financial circumstances to your debt-to-income ratios: front-end and back-end.
Front-End DTI Ratio
The front-end ratio—or “housing ratio”—is your projected monthly housing costs in comparison to your gross monthly income (before taxes).
To find your front-end ratio, the bank or lender will assess your projected monthly mortgage payment. This includes the following housing costs, collectively known as the “PITI”: principal, insurance, taxes, and interest.
They will divide this number by your monthly gross income.
Lenders’ preferences and limits vary, but a typical limit for front-end ratio is 28%. (Federal Housing Administration loans have a maximum front-end ratio limit of 31%.)
Back-End DTI Ratio
The back-end debt-to-income ratio compares your total debt obligation—not just projected housing debts—to your gross monthly income.
To find your back-end ratio, the lender will add together your total debt obligations, including the projected PITI (as described above), as well as credit card minimums, car payments, and of course, student loans payments.
Lenders typically prefer to see a back-end ratio under 36%. (For FHA loans, you can hold a back-end ratio of up to 43%.)
How Student Loans Affect Your Mortgage Application
Again, just having student loan debt won’t stop a lender from issuing you a mortgage. However, if you’re planning on buying a house with student loans, there are several ways in which your loans can impact the application process:
The main way that student loans can affect your mortgage application is by raising your DTI ratios. As discussed above, your DTI is the comparison of what you owe to what you make, so owing a significant amount in student loans doesn’t necessarily mean your DTI will be high. If you make enough money per month to offset your DTI, your student loans won’t negatively impact your application in this way.
Another key factor that lenders consider when they’re processing a mortgage application is credit score and history. There’s a common misconception is that student loan debt lowers your credit score. However, this isn’t necessarily the case. Payment history accounts for 35% of your FICO score, which means if you make your student loan payments on time every time, they will impact your credit positively, rather than negatively.
If you’re saving up for a down payment on a house, loan deferment can seem like a good strategy (and it may be). With federal student loans and some private loans, you can sometimes temporarily defer (stop making payments) for a set period of time. Depending on the circumstances, you may or may not accrue interest during that time. However, if you’ve stopped making payments on your loan, lenders will typically estimate your monthly loan payment based on the total you owe. This can end up reflecting badly on your DTI, since their estimated payment amount will most likely be higher than what you would actually pay per month.
Other Factors to Consider
If you’re planning on buying a house with student loans, it’s important to understand some other major factors that can help lenders decide whether or not to issue you a mortgage, in addition to those that are directly impacted by your student loan debt.
You may make a substantial income at your current job—enough to set your debt-to-income ratio well under the threshold. However, if you haven’t been employed very long, your employment history could prevent you from buying a house. This can especially affect recent graduates who have secured their dream job and feel ready to buy a home. Many lenders will require you to have at least two years of steady employment before they’ll accept your income numbers.
Your down payment amount is a key factor in whether or not you can afford to buy a home. If you don’t have a low enough DTI at a particular mortgage rate, you can improve your ratio by making a bigger down payment. The bigger down payment you can make, the less likely your student loans are to impact your ability to buy a house.
If your debt-to-income or other factors prevent you from qualifying for a home loan, lenders may allow you to apply with a cosigner. A cosigner on your mortgage must be a family member, and they must have a stable income, high credit, and a low DTI to qualify.
How Much Can I Afford?
To find out how much you can afford to pay on a mortgage per month, and therefore how expensive a home you can afford to buy, you can use the ideal DTI percentage of under 36%. Add up your current debts and compare that number to your income to see how much wiggle room you have to add in a mortgage payment while staying under 36%.
Additionally, you should generally spend less than 28% of your income on your mortgage payment.
To make this calculation a bit simpler, there are several online calculators available to plug in your data and receive a result. Bankrate’s online calculator also allows you to put in your down payment amount and loan term to estimate the price range you should be looking at while shopping for a home.
How to Buy a House with Student Loan Debt
Whether you’re planning to apply for a mortgage in the next year or you decide to wait a while, these are some ways you can prepare for the application process to improve your odds.
Save Up for a Down Payment
The best way to prepare yourself for buying a house is to start saving money as soon as possible that you can put towards your down payment. The minimum down payment for most conventional loans is between 3%-10% (based on your credit), but a payment of 20% is considered ideal. To start saving, figure out how much you’ll need to put away each month to save up enough money for the down payment within a year, three years, five years, or 10 years.
Pay Off Your Student Loans Faster
One option you have if you need to lower the “debt” side of your debt-to-income ratio in order to qualify for a mortgage is paying off your student loans faster. You may be making minimum payments on your student loans as a way to save money or give yourself more leniency. But if you’re working towards buying a home and you can afford to pay more on your student loans per month, it may be wise to do so.
Refinance Your Loans or Enroll in an IDR
If you can’t afford to put more money towards your student loans, but you still need to lower your DTI, you can refinance your loans or enroll in an income-based repayment plan. Income-driven repayment plans (IDRs) are available for federal loans, and they’re based on your monthly income. There are several different types that you may qualify for, and they can lower your monthly payment significantly enough to put your DTI ratio under the limit. You can apply here. Private loans are not eligible for IDRs, but you can refinance your loan to extend the terms and pay less monthly. To do so, you’ll need to talk to your lender about refinancing or consolidating your loans.
Improve Your Credit
Student loans can either positively or negatively impact your credit, just like other debts, depending on how well you handle your debt. If you’ve missed payments on your student loans, your credit may be too low to qualify for a mortgage. To boost your credit score, make sure you’re paying your bills on time, and follow these other helpful tips:
- Reduce Credit Utilization
Credit utilization is the amount of your available credit lines you’ve used. For example, if you have two credit lines totally $3,000, and you’ve used $1,500 between the two lines, your credit utilization is 50%. Generally, you’ll want to show that you’re using your credit lines but keep your credit utilization as low as possible.
- Check Your Types of Debt
Lenders like to see that you can handle different types of debt, including installment debt like loans and revolving debt like credit cards. If you only have student loans on your credit report, you may consider taking out a credit card to show your ability to handle multiple debts (remembering to keep your utilization low).
- Keep Accounts in Good Standing
If you already have multiple types of credit in your file, you’ll want to keep it that way, as long as your accounts are in good standing. If you have a credit card, for example, with low utilization that you’ve always paid on time, you’ll want to avoid canceling that credit card. While it may seem like a good idea to have as little in your credit report as possible, you want credit lines like these to show your history of on-time payment and credit management skill.
Reduce Other Debt Expenses
If you pay other debt expenses on a monthly basis—such as car payments or credit card payments—you can lower your DTI ratio by refinancing or paying off those debts. If you have multiple credit cards, for example, you may be able to consolidate your debts with one single lender. If you’re making car payments, you may be able to renegotiate your loan to extend the terms and pay less per month (note that you’ll most likely pay more interest in doing so).
Work Towards That Promotion
The other way to improve your debt-to-income ratio—other than lowering your monthly debt expenses—is to increase your income. If you’re working towards a promotion or raise at work, or you think you may be changing jobs soon, it may be wise to wait and apply for a mortgage after your pay increases. Remember that if you change employers, some lenders may need at least two years of employment history with your new employer before they accept income amounts.
Is Buying a House with Student Loan Debt a Good Idea?
Whether or not buying a house with student loan debt is a good idea depends on your goals and circumstances. Is it more important to you to be debt-free faster (potentially saving money on interest) or to begin your journey as a homeowner (potentially saving money on rent)? The answers to questions like these will be influenced by your living situation, family life, and resources.
With the above information in hand, you may find that buying a house with student loans is well within your ability, or you may decide it’s worthwhile to wait and pay down your student loans first.