Maybe you’ve graduated college and secured your first job. The paychecks are coming in, and now it’s time to think about moving out of your parent’s house. Maybe you have simply decided to make the leap from renting to owning. While pursuing a higher education is an applaudable endeavor, for many, it comes with a significant cost – student loan debt. Aspiring homeowners may wonder how that debt will affect their ability to get a mortgage. Especially as of recently, since roughly 28 million borrowers will soon be required to resume payments in October of 2023 on their student loans for the first time since the March 2020 pandemic-related pause.
The good news for most graduates is that they can qualify for a mortgage as soon as 30 days after starting their first job. We cover some specifics on how to qualify for a home in our blog, Getting a Mortgage After Graduating College. In this article, we will break down the general way in which student loan debt can play a part in your ability to qualify for a mortgage.
Debt-to-Income Ratio
Student loans don’t affect your ability to get a mortgage any differently than other debts like a car loan or credit card debt. One of the critical factors lenders consider when evaluating mortgage applications is the debt-to-income ratio (DTI). DTI is a measure of your monthly debt payments compared to your monthly income. Lenders prefer borrowers with a lower DTI, as it indicates a higher capacity to take on additional debt, such as a mortgage payment.
Student loan payments contribute to your DTI, so it’s important to consider how that will affect your ability to meet the acceptable DTI percentage thresholds. In some cases, you may need to reduce any other debts or wait till your income increases. The type of loan you apply for can also play a part in how your student loan debt is calculated. If you apply for an FHA loan, a mortgage backed and insured by the Federal Housing Administration, these loans typically require a lower minimum down payment and easier credit qualifications. Changes in how lenders can calculate monthly student loan payments in relation to your overall DTI can make FHA loans a better option for those with student loan debt.
Credit Score Impact
Your credit score is another crucial factor in mortgage approval. Mortgage lenders use your credit score and history to establish the amount of risk that they take by approving your loan. The higher the score you have, the better. While student loans don’t negatively impact your credit score directly, they can indirectly affect it. If you miss payments or default on your student loans, your credit score will take a hit, which can make it harder to qualify for a mortgage or result in higher interest rates.
To avoid higher interest rates and the possible risk of denial, it’s essential to make your student loan payments on time and manage your overall credit responsibly. A strong credit score can help offset the negative effects of student loan debt. There are ways to improve your credit score, and you can read more about them in our blog – How Can I Improve a Bad Credit Score to Get a Mortgage.
Loan Types and Down Payments
As we touched on earlier, there are various types of loans that you can apply for when getting a mortgage. The main ones are Conventional Loans, which are backed by private investors; FHA loans – backed by the Federal Housing Administration; USDA loans – U.S. Department of Agriculture-backed loans that aim to help borrowers in more rural areas; as well as VA loans – backed by the Department of Veteran Affairs. The type of student loan you have also plays a role in the mortgage approval process. Federal student loans generally offer more favorable terms and repayment options than private loans. If you have federal loans, lenders may be more lenient when assessing your mortgage application.
Each loan type has different requirements for how lenders can calculate student loan debt into your overall DTI. Changes to these guidelines were made in June of 2021 – and with the reinstatement of student loan payments in 2023, we will be keeping our eye out for any future changes being made. It’s best to chat with one of our experienced loan advisors if you have any questions about how the type of student loans you have will affect your mortgage application. Our advisors can work with you to find the best loan type suited to your situation and needs.
Additionally, the size of your down payment can make a significant difference. A larger down payment can reduce the loan-to-value ratio (LTV) since your new mortgage payment will factor into your DTI. The larger the down payment you make, the lower your monthly payment will be, which will help lower your overall DTI. However, saving for a down payment while managing student loan payments can be challenging for many borrowers. Down payments can be gifted by a relative, or a relative may even be able to sell you a home with no money down. Should your relative have any concerns about gift tax, you can read about that here. You can also apply for down payment grants. There are local and national down payment assistance programs available to first-time homebuyers.
Income and Career Prospects
Your income and career prospects also factor into the mortgage equation. Lenders may view you more favorably if your student loan debt is relatively low compared to your income and you have a stable job with good growth potential. However, high debt combined with a low income or uncertain career prospects can make it difficult to secure a mortgage
Loan Forgiveness and Repayment Plans
It’s worth exploring loan forgiveness programs and income-driven repayment plans if your student loan debt is a significant barrier to homeownership. Some government programs can help reduce your monthly payments based on your income and family size. Moreover, certain professions may qualify for loan forgiveness after a certain number of years of service.
Conclusion
While student loan debt can undoubtedly affect your ability to obtain a mortgage, it’s not an insurmountable obstacle. Student loan debt may be a part of your life for years to come, and waiting to purchase a home has its own costs. It’s important to remember that paying rent costs you 100% interest, and the rising costs of houses over the last several years only point to housing prices not coming down soon.
Careful financial planning, responsible debt management, and strategic choices can help you achieve your homeownership dreams despite the burden of student loans. It’s important to understand the impact of your student loan debt on your financial profile, work towards improving it, and explore available resources and programs that can aid in your journey toward becoming a homeowner. If you have any questions at all, reach out to one of our loan advisors today. We can help you set a plan to make owning a home part of your future.