Don’t Let Student Loan Debt Hold you Back from your Homebuying Dreams
If you recently graduated from college, chances are you have some student debt. But that doesn’t mean you have to let your debt get in the way of #lifegoals, like buying a house. You might feel like your student loan debt is taking over your life—but it IS possible to qualify for a mortgage, even while paying off your student loan debt.
In fact, over the past few years the mortgage industry has made qualifying guidelines more flexible for borrowers with student loan debt.
If you are looking to purchase a home now or in the future and you have student loan debt, here are some factors that will determine your eligibility.
Factor 1: Your Debt-to-Income Ratio
Debt-to-income ratio (DTI) is calculated by adding up all your monthly debt payments, including expected Housing payment(s), and dividing them by gross monthly income.
So, what is considered a debt payment? Student loans, mortgages, auto loans, credit card debt, and any other installment or revolving debt that you are obligated to repay.
Lenders generally follow something called the “28/36 rule.” This means that no more than 28 percent of your gross income should go to your mortgage payment, property taxes, and insurance. Additionally, your total debt payments, including expected mortgage payment, should be no more than 36 percent of your gross income. However, some loan programs, such as the FHA loan, will qualify borrowers with DTIs of up to 43 percent (or higher in certain circumstances.)
Some borrowers might worry that their student loan debt will increase their debt-to-income so much that they won’t be able to qualify for a mortgage.
So how is student loan debt Calculated into your DTI?
Conventional loans use .50-1% of the payment shown on the credit report, where previously you were required to qualify using the full amount of student loan debt you we’re paying each month.
For example, if you are paying off a $40,000 student loan debt with an income-based payment plan, under previous rules, your lender would have calculated your student loan debt at $200-$400 each month. Under current rules, your student loan debt could be calculated as low as $76 per month.
If the loan is in deferment or if no payment is reported, your lender will still use .50-1% of the loan balance.
Regardless of the payment status, FHA will determine the debt by using the greater of:
- 1 percent of the outstanding balance on the loan
- the monthly payment reported on the Borrower’s credit report
- the actual documented payment, provided the payment will fully amortize the loan over its term.
So, even if your monthly student loan payment is lower than 1% of the balance of your student loan, you’re still required to qualify you with the higher amount. This means a higher DTI, lowering you potential buying power.
VA Loan Student debt guidelines have also been updated recently to grant more leniency to those with student loan debt.
If student loan debt is deferred for more than 12 months after the mortgage closing date, then the VA will exclude the obligation from the DTI calculation.
If the student loan debt isn’t deferred 12 months post-closing date, the VA will use the higher of:
- Payment on credit report
- 5% of outstanding balance divided by 12 months (example: $25,000 student loan balance x 5% = $1,250 divided by 12 months = $104.17 per month is the monthly payment for debt ratio purposes).
However, if the actual documented payment on the credit report is fully amortized the loan over its term, then this amount can be used.
Need to lower your DTI?
There are a few options to reduce, consolidate or defer your monthly student loan payments to help reduce your debt-to-income ratio:
- Initially reduce your monthly payments by switching to a graduated repayment plan. With a graduated repayment plan, payments start low then rise every two years as your income level rises.
- Request to lengthen your term, which will reduce the amount that you owe each month. You will pay more interest in the long run but will reduce your debt-to-income ratio in the meantime.
- Consolidate different student loans at a lower interest rate. This will reduce your payments and package them together in one convenient monthly payment.
Of course, as mentioned earlier, your payment will factor into your DTI differently, depending on your specific loan program so it’s probably best to speak with a loan officer before doing any of these three things.
Factor 2: Your Credit Score
There is good news for those who pay their student loans on time each month—your building a strong credit profile.
Borrowers with better credit scores can qualify for lower interest rates, which means they’ll be eligible to qualify for lower monthly payments. Unlike credit card debt, student loan debt is an installment loan in which you are required to pay a fixed amount each month. Owning a large amount in an installment debt won’t hurt your credit score like a large amount of credit card debt would.
So, pay your loan on time each month to help build your credit profile.
Factor 3: Your income and down payment
If your debt-to-loan ratio is too high, you could offset that ratio by saving for a large down payment. This will reduce the amount you have to finance and will give you a lower monthly payment, changing your debt-to-income ratio.
If you’re unable to save for a down payment, talk to your loan officer about any grants or down payment assistant programs that you might be eligible for.
A higher income will also help offset your DTI—so consider negotiating for a raise or starting a side-hustle.
So, what’s the bottom line? Yes, it could be more challenging to qualify for a mortgage with student loan debt, but it isn’t impossible. It’s important to know where you stand and speak with a qualified mortgage professional who can help guide you in the right direction.
The information contained herein (including but not limited to any description of TowneBank Mortgage, its affiliates and its lending programs and products, eligibility criteria, interest rates, fees and all other loan terms) is subject to change without notice. This is not a commitment to lend.
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