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Buying a home is one of the most significant financial investments you’ll ever make. When you’re trying to buy your first home, you’ve likely budgeted and saved for years to buy your dream home. Unfortunately, there’s one big factor that may throw a wrench in things: Student loan debt.
That’s a grim picture but, despite appearances, the U.S. housing market continues to boom. People are buying houses, so debt must not be that much of a hindrance, right?
Yes and no. You can buy a house with a significant amount of debt (and specifically student loan debt) but it’s a little more complicated than if you’re debt-free. While there’s some talk of student loan debt cancellation in coming years to aid young prospective homebuyers, we should not hold our collective breath.
If you have student loan debt but want to buy a house, it can be difficult to get a mortgage. But it’s not impossible by any means. This guide will help you understand how to take on a mortgage responsibly, without falling behind on student loan payments or crippling your financial health.
How will student loan debt impact your ability to obtain a home loan?
Few Americans are completely debt-free. As such, having some debt is fine when applying for a mortgage. The most important thing lenders consider during the loan application process is whether you have enough income to make your payments on time.
To do that, lenders use a formula called debt-to-income ratio, or DTI. This is a measure of the percentage of your monthly income that goes toward debt. If you have a high DTI ratio, you may struggle to get approved for a mortgage. That’s why it’s important to calculate DTI yourself before applying for a loan.
Calculating your DTI is simple. First, add up all of the monthly payments you make including just the regular, recurring, and required payments. These include:
- Your rent or monthly mortgage payment (if you intend to retain your current home)
- Minimum credit card payments
- Student loan payments
- Auto loan payments
- Personal loan payments
- Any court-ordered back taxes, alimony, or child support payments
Leave out any expenses that vary month to month like utility bills, transportation costs, or 401(k) or IRA account contributions. Remember to include only the minimum required payment you need to make each month as this will help you get the most favorable DTI.
Once you add up all those expenses, divide that number by your total pre-tax monthly income. If you’re applying for a loan with someone else, include their income (and debts if different) in your calculation as well. Then, multiply the resulting number by 100 to get your DTI.
The basic calculation looks like this:
(Total Monthly Debt Payments) / Monthly Pre-tax Income = DTI
Using DTI to see what you can afford
Lenders typically want to see a DTI of 45% or lower after adding housing costs to your existing debt. The true "maximum DTI" is ultimately determined by an automated system that considers every part of the loan application (DTI, down payment, credit score, occupancy, property type, and so on). Those with good credit purchasing a primary residence may get an approval with a DTI up to 49.99%.
Let's walk through an example:
Your gross monthly income is $6,000. A typical max DTI equals 0.45, multiplied by $6,000, which is $2,700. That means your monthly debts — including mortgage debts — cannot exceed $2,700.
You can work backward from there, finding the difference between $2,700 and the sum of all your debts. That will give you the maximum mortgage payment you can expect to get approved for. For instance, if your existing debts are $800 per month, then your max mortgage payment is $1,900.
Remember, mortgage payments could also include property taxes, homeowners insurance, mortgage insurance, and other additional fees so keep that in mind when determining a house hunting budget.
Should you pay off your student loan debt before applying for a mortgage?
The million dollar question: Should you pay off your student loans before buying a home? Like most things in real estate, there isn’t really a yes or no answer. Everyone has a different appetite for risk and everyone has different debt situations.
Most importantly, look at your DTI. Banks may be able to approve you up to a DTI of 50%, but do you feel comfortable applying for a mortgage that would basically max out your DTI? Your personal preference may be more in the 30-35% DTI range.
Additionally, the home you buy may require some investment. Even turnkey houses can have problems emerge in the first year or two of ownership. You should budget for home maintenance costs, as well. You’re not renting anymore!
You should also look at other financial obligations that might not factor into your DTI. If buying a home will interfere with retirement contributions or make it impossible to lead a lifestyle you enjoy, you should probably pay down your student loans first.
Finally, consider your student loan interest rate. If you have a high interest rate on your student loans, they’ll cost more over time so it’s in your best interest to pay them down before investing in a home. If you aren’t paying enough each month to cover the accruing monthly interest, you’re not actually getting out of debt. You need to make sure you’re able to go in the right direction with your student loan debt while also building equity in a home.
If you have savings for a down payment, a low DTI, a good student loan repayment plan, and you can meet other financial obligations and desires, then go ahead and look to buy. Otherwise, consider paying down your debt some more.
How to qualify for a mortgage with student loan debt
If you’re set on buying a home despite your student loans, here’s what to consider moving forward.
Decrease your DTI
Unsurprisingly, the best thing you can do to qualify for a mortgage with student loan debt is decrease your DTI. Paying down your student debt might be the best way to do this, but there are other ways, as well. If you’ve almost paid off your car, it might benefit you to pay the last few months in one lump sum to get that debt off your back. If you have court-ordered back taxes, it might behoove you to pay them all at once.
One thing to keep in mind is the “28/36 qualifying ratio” that many lenders use to determine if applicants are eligible for the best rates. This ratio states that you should spend no more than 28% of your gross monthly income on housing expenses, and no more than 36% on all expenses — including the new mortgage payment. Calculating your DTI will help you also determine these numbers so you’ll know if you could get a better rate by lowering your DTI.
Examine all loan types
With a high DTI, you may not apply for conventional loans from anywhere. But you could still qualify for a number of other options.
FHA loans, backed by the Federal Housing Administration, have a maximum DTI of 57% in many cases. If you’ve served in the armed forces or National Guard, you could qualify for a low-interest VA loan. You could also discuss a graduated payment mortgage with your lender, which lets you start with smaller payments that increase during the lifespan of the mortgage.
Some of these alternative loans also offer down payment assistance programs that can help many home buyers. Many states and cities offer these and they’re acceptable to most lenders. For instance, FHA loans mean you could make a down payment of as little as 3.5%. If you choose to live in a rural area, you may qualify for a USDA loan, which requires no down payment.
Do a little research and discuss with a mortgage broker to find out what programs you might qualify for at the federal, state, and local levels. Most people with student loans can find at least something to help them get approved for a mortgage.
Improve your credit score
Your credit score is the number one factor lenders use to determine whether or not to lend you money. It’s basically a rating of how good you are at paying back debt, after all.
Fortunately, as long as you’re making payments on time, your student loan debt probably won’t hurt your credit score. But to give your score a boost ahead of applying for a mortgage, you could do the following:
- Pay all of your bills in full on or before the due date.
- Manage your credit utilization by using as little of your available credit as possible.
- Keep old accounts in good standing open to help your positive credit history.
- Use different types of credit like credit cards and installment loans (like car payments or student loans) to demonstrate you can handle multiple types of debt.
- Check your credit report before buying a home to ensure it’s accurate and up to date.
Increase your income
Finally, the obvious thing: Increasing your income is a great way to lower your DTI and make you a more attractive mortgage applicant.
Picking up a few more hours at work or starting a side hustle can give you a positive cash injection. You’ll have to prove that this extra income is regular and recurring for it to count toward your DTI, though. Most lenders want to see at least a two-year history for all of your sources of income.
Yes, you can buy a house while in student loan debt. A better question is should you? That answer is different for everyone and depends on a multitude of factors. Can you comfortably carry two large debts over long periods of time? Is your income large and reliable enough to support a mortgage on a house you love? Can you still make retirement contributions and lead the lifestyle you want with two big debts?
Each of these questions contains their own nuance and only you know the right answers. Consider what you can afford and what matters to you, and spend some time shopping for mortgages to ensure you get the best rate you can. There’s nothing wrong with buying a home with student loan debt — just make sure you can do it responsibly.