If you’re like millions of Americans who borrowed money for your college education but want to build a life for yourself, you may be wondering how to go about buying a house with student loan debt. This can be a tricky prospect, but the good news is—it’s not impossible! In this guide we’ll outline everything you need to know about student loan debt and mortgage deals so you’ll be prepared for the process when the time is right for you.
Now that you know that getting a mortgage with student loan debt isn’t just a pipe dream, it’s time to learn more about what to expect when you do decide to take the leap and apply for a mortgage. Let’s get started.
Step One: Assess Your Situation
Before you begin to invest too heavily in the idea of buying a house with student loan debt, you need to take a step back and assess your situation as objectively as possible. Can you buy a house with student loan debt? As we’ve already stated, the answer is certainly yes, but whether you should take on a mortgage with student loan debt and whether you really want or need to is another issue entirely.
Under any circumstances, buying a house is a personal decision. It’s also one of the biggest financial decisions you will make in your lifetime. If you already have a substantial amount of student debt, the weight of this decision will be even heavier. You need to ask yourself if you’re comfortable adding another large loan to your debt portfolio. Your level of comfort will likely depend on a variety of different variables, chief among them your income forecast. After all, your ability to pay off a mortgage with student loan debt is directly related to how much money you make now and how much you’re likely to make in the future. If your income is stable and your job offers advancement opportunities, then you may feel more confident about your ability to handle additional debt. You also need to consider how managing two large loans at once will affect your lifestyle and your other priorities. Will it cause you to have to make sacrifices you aren’t prepared for or negatively affect your ability to save for retirement, for instance? These are important factors to consider.
In addition to financial considerations, you will also want to evaluate your reasons for buying a house with student loan debt. Are you wanting to settle down and start a family, for example, or do you want to put what used to be rent money into something more worthwhile? Alternatively, do you simply feel like buying a home is the next logical step in your life, or do you feel pressure from friends or family? While there’s no one right or wrong reason to take on a mortgage, you do want to make sure it’s something you really want to do before signing on to such a large loan. Remember, you’ll be paying the mortgage while also juggling student loans, so this is solely your decision.
Step Two: Analyze Your DTI
If you’ve assessed your individual situation, both financially and otherwise and decided that buying a house with student loan debt is something you truly want to pursue, then the next step is to analyze your DTI, or debt-to-income ratio. Your DTI is a determination of how much debt you have weighed against how much income you bring in. Mortgage lenders are interested in your DTI because it predicts how likely you will be to pay back the mortgage loan. In essence, it’s a way for banks to assess the risk they’re taking when lending you money.
There are two types of DTI that the bank will evaluate— front-end DTI and back-end DTI. The front-end DTI determines how much of your income will be going to your mortgage payment and other housing costs. This is why it is sometimes referred to as the housing ratio. In order to calculate the front-end ratio, banks divide your monthly mortgage payment by your monthly income. For example, if you make $5000 a month, and your mortgage is $1500 a month, then your front-end DTI ratio would be $1500/$5000, or 30%. Most banks will decline loans with a front-end DTI above 31, but each individual lender will set their own limits.
On the other hand, the back-end DTI determines how much of your income will be allocated for all types of debt, not just your mortgage payment. This means any car payments, credit card payments, and student loan payments will be weighed against your monthly income. For instance, in addition to your $1500 mortgage payment, let’s say you also have a $300 a month car payment, a $200 a month credit card bill, and a $350 a month student loan payment. Assuming you still make $5000 a month, then your back-end DTI ratio would be your income divided by your total monthly debt, or $2350/$5000, or 47%. Although some banks will approve a loan with a back-end DTI of up to 50%, most won’t tolerate anything over 36%. In this example, you can see how your student-loan debt can impact your ability to be approved for a mortgage.
Step 3: Decrease Your DTI.
As we’ve noted, the lower your debt-to-income ratio (both front-end and back-end), the more likely it is for you to qualify for a mortgage with student loan debt. In this section, we’ll discuss ways to decrease your DTI, which will put you in an advantageous position when you approach a lender for a mortgage approval. There are two basic ways you can decrease your DTI ratio—either by reducing your monthly debt or increasing your monthly income.
For most people, the most practical way to decrease DTI ratio is to reduce the amount of monthly debt you’re responsible for. There are various ways you can do this, depending on what type of debt you have. For example, if you have credit card debt, you will most likely want to pay off this debt first as credit card loans typically carry higher interest rates than other types of debt. Another popular way of decreasing debt when considering buying a house with student loan debt is to decrease the amount of money you owe every month towards paying off your student loans. To do this, you have a few options.
If you have several different student loans, you may be able to consolidate these loans into a single loan with a lower monthly payment. Consolidation has other benefits as well, such as the possibility of improving your credit score over time. We’ll discuss this potential benefit in more detail later in the article. If you decide to go this route, you’ll need to look at what types of student loans you have. Federal loans can be consolidated into one direct consolidation loan through the federal government’s loan consolidation program whereas private loans will need to be consolidated through a private lender.
Whether or not you decide to consolidate your student loans as a strategy for buying a house with student loan debt, you may be able to qualify for a repayment plan that will effectively lower your monthly student loan payment. The Revised Pay As You Earn program, or REPAYE, in particular may be a suitable option for individuals looking to secure a mortgage with student loan debt. With REPAYE, your monthly payments are guaranteed to be lower than 10% of your income, and as an added benefit, any remaining balance on the loan will be forgiven after 25 years of repayment. Unlike other income-contingent repayment plans, you do not have to demonstrate financial hardship in order to qualify for REPAYE. When refinancing your loan under an income-contingent repayment plan, you do need to keep in mind that some lenders will evaluate this information differently. More specifically, some banks make lending decisions based on the total student loan balance rather than the monthly payment amounts.
Increasing your income is another effective way to decrease your DTI in order to qualify for a mortgage with student loan debt. This may be a good time to take on a second job or ask for that raise you’ve earned.
Step 4: Improve Your Credit Score
The good news for those contemplating buying a house with student loan debt is that mortgage lenders place priority on the borrower’s credit score when deciding whether or not to approve a home loan. Unless you’re in default on your student loan or have missed payments, it’s not likely that your student loans are having much effect—either positive or negative—on your credit score.
If you are having trouble making payments, then this is something you’ll need to take care of immediately, certainly before you begin the process of buying a house with student loan debt. In order to resolve the problem, you should ask yourself why the payments have become a problem for you. Typically, there are two reasons people struggle making their student loan payments on time—either because they have so many different student loans that it’s difficult to keep track of what payments are due when or because the payments have begun to put a heavy strain on their finances. Either way, there are solutions that can make making timely student loan payments more manageable.
Student Loan Consolidation
If you’ve found yourself struggling to keep tabs on multiple student loans, then your best bet is to consider consolidating your student loans. Remember, most types of federal loans can be consolidated into a single direct consolidation loan. Most everyone will qualify for a federal direct consolidation loan, and your credit score isn’t an issue at the time of application. The only requirement is that you’re no longer taking classes on a full or part-time basis. The interest rate on this new loan will be set at a fixed rate, and this rate will be based on the average of all of your original federal loans.
If you have private student loans, student loan consolidation may not be an option for you at this time unless you have someone willing to cosign on the loan for you. This is because private lenders will check your credit score to determine how big of a risk they’ll have to take to pay off your original loans. A cosigner would agree to make payments on the loan if you’re unable to. If you do decide to consolidate private loans, keep in mind that the credit check itself may have a negative impact on your credit score, at least temporarily. This could affect your ability to be approved for a mortgage with student loan debt.
Federal Student Loan Repayment Plans
In situations where student loan payments are putting a strain on the household budget, the best option is to consider a repayment plan that takes into account your income. There are many different types of repayment plans that can free up monthly funds for other things—such as a mortgage payment, for instance—and when you’re able to make payments consistently and on time, your credit sore will improve over time, making buying a house with student loan debt more feasible. Let’s look at some of the more common types of repayment plans that you may qualify for.
- Income-Based Repayment Plan (IBR)
One of the most popular types of income sensitive repayment plans offered by the federal government is the income-based repayment plan, or IBR. Under this plan, your monthly student loan payment will be reduced to either 10% or 15% of your discretionary income, depending upon when your loans were originated. Discretionary income is the amount of money left over after you pay for your rent, utilities, and other necessities. If you took out your original student loans prior to July 1, 2014, then your new student loan payment will be 15% of your discretionary income under the income-based repayment plan (IBR). If you’re a new borrower, and your initial loans were originated on or after July 1, 2014, then your student loan payment will be 10% of your discretionary income. The repayment period will also differ based on whether or not you’re a new borrower. Specifically, if you’re a new borrower, your repayment period will be 20 years; otherwise, it will be 25 years. Any remaining student loan balance that remains after the repayment period will be forgiven under the IBR plan.
- Pay As You Earn Repayment Plan (PAYE)
Another common income-sensitive repayment plan is Pay As You Earn Repayment Plan, or PAYE. If you qualify for this plan, you’ll only be obligated to pay 10% or less of your income towards your student loans. Even if you get a raise or your income increases during the repayment period, your payment will never exceed 10% of your income, and it will never be more than it would have been on a standard 10-year repayment plan. After 20 years of payments under PAYE, any remaining loan balance will be forgiven. To be eligible for PAYE, you may have to meet some initial income requirements. In addition, PAYE is not available for all loan holders as eligibility also depends upon when the loans were first originated.
- Revised Pay As You Earn Plan (REPAYE)
If you find that you are not eligible for PAYE for whatever reason, you may want to consider the Revised Pay As You Earn Plan, or REPAYE, as a viable alternative. You’ll be much more likely to qualify for this income-sensitive repayment plan since you don’t need to demonstrate a financial hardship and it doesn’t matter when the loans were first taken out. As with PAYE, loan holders will pay 10% or less of their income towards their student loan debt, and after 25 years, any remaining balance on the loan is forgiven.
Keep in mind that income-sensitive repayment plans will extend your repayment period. While this will lower your monthly payments, it will also increase the total payoff on the loan since interest will accrue over a longer period of time.
Other Things to Consider When Buying a House With Student Loan Debt
As you know, banks consider a lot more than just your student loan debt when deciding whether to approve you for a mortgage. While getting your student loans in check prior to buying a house is certainly a good idea, there are other things you can do to increase your chances of being approved for a home loan.
- Down Payment
No matter what your student loan balance is, the bigger your down payment, the better your chance for getting a mortgage. After all, the more money you pay for a house upfront, the less the bank will have to lend you, making the risk a smaller one for the lender. A 20% down payment on the loan is idea, so start saving up!
- Employment History
As we’ve discussed, income is an important factor when applying for a mortgage with student loan debt. Some banks are hesitant to accept your income if you haven’t had your current job for at least two years though. The way they see it, you could switch jobs or be laid off at any moment, and your income could decrease. Therefore, if you’re just out of school and haven’t put in much time in the workforce, your mortgage lender may not think your income numbers are reliable. Thus, it’s important to build a solid work history before attempting to get a home loan.
When applying for a mortgage with student loan debt, you also need to consider how much money you have in savings. Banks will look at your savings account to determine if you can afford closing costs and future mortgage payments. In general, you’ll want to have money set aside for closing costs as well as a minimum of two monthly mortgage payments set aside. Of course, the more money you have in savings, the more confident banks will be that you will be able to make your mortgage payments, even if your income dips or you have unexpected expenses.
Frequently Asked Questions on Getting a Mortgage With Student Loan Debt
Q: Can you buy a home with student loan debt?
A: Yes. Buying a house with student loan debt is possible, but it may be more or less complicated depending on your individual situation and the total amount of your student loans.
Q: How do student loans affect mortgage approvals?
A. Banks look at student loans much like they look at any other type of debt. They want to know how much of your income the loans represent as well as your payment history. If you’re able to manage your monthly student loan payments and you’re making payments on time, student loans shouldn’t disqualify you for a mortgage.
Q: Do student loans affect my credit score?
A: Everyone knows that your credit score is an important factor when attempting to buy a home, and many student loan holders worry that their loans are affecting their scores and thus, their ability to qualify for a mortgage. These concerns are largely unfounded though. Even if you owe a lot on your loans or have multiple student loans, it’s not likely that your credit score is being affected significantly unless you’ve missed payments or went into default.
Last Words On Buying a House With Student Loan Debt
Clearly, getting a mortgage with student loan debt can be a complex issue, but there are some key points we want to leave you with in an effort to simplify the process.
- Wait for the right time.
Managing student loans and mortgage payments is a big deal, so it’s important to wait for the right time. Although it’s reasonable to want a permanent housing situation as soon as possible, rushing into the process can cost you in the long run. For instance, you may not be able to get a mortgage with a reasonable interest rate or you may not qualify for the house you really want to be in for the long haul. Do your due diligence and take steps to get your student loan debt in order before taking on a mortgage with student loan debt.
- Your DTI Matters.
Your debt-to-income ratio is critical when attempting to be approved for a mortgage with student loan debt. Obviously, banks want to know that you’re going to have enough money to pay your mortgage each month without defaulting on the loan, so the lower your DTI, the more likely it is that you’ll be approved for a loan, and the more likely you’ll be to secure a reasonably low interest rate. To decrease your DTI, you can pay off some of your debt to reduce the amount of money going out each month. Although paying off your student loans may not be a feasible option, you can consolidate your student loans or apply for a repayment plan that could lower your monthly payments.
- Your Credit Score Also Matters.
Your credit score is also an important factor when buying a home with student loan debt. From a bank’s perspective, the higher your credit score, the more likely you’ll be to make timely payments on your home loan. Unless you’re in default or have missed several payments, your student loans aren’t likely impacting your credit score significantly. If you are having trouble making regular payments, consider student loan consolidation or an income-sensitive repayment plan to get back on track before it damages your credit score.
With careful planning and strategic action, your dream of buying a home with student loan debt can soon become a reality.