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Ways That Student Loans Can Affect Your Mortgage

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In a Nutshell

Homeownership is a major life goal for many people. In recent years, though, economic challenges have prevented many people from pursuing this goal. Student loan debt is often cited as a reason why so many people are waiting longer than ever to buy a home.

Written by Attorney Paige Hooper.  
Updated July 19, 2021


Homeownership is a major life goal for many people. In recent years, though, economic challenges have prevented many people from pursuing this goal. Student loan debt is often cited as a reason why so many people are waiting longer than ever to buy a home. 

There’s good news, though. It's possible to qualify for a mortgage even if you have a lot of student loan debt. That said, student loans have a significant effect on your debt-to-income ratio and credit rating, which are two of the key factors in qualifying for a mortgage. This article discusses the ways in which your student loans can impact your chances of getting a mortgage and ways to improve your odds despite your current student loan debt.

People With Student Loans Are Able To Take Out Mortgages

Three primary factors influence whether you will qualify for a mortgage loan: 

  1. How difficult it will be for you to pay your potential house payment on time each month. This is estimated using your debt-to-income ratio. This calculation determines how much money you have available each month to spend on mortgage payments.

  2. Your estimated creditworthiness, or how likely it is that you will default on the loan. This is estimated based on your current credit rating, as well as your past credit history.

  3. How much money you have available to put down on the loan. A larger payment offers lenders more security. It also reduces the total amount of the purchase price that you’ll need to finance.

Down Payment Requirements

It can be difficult to save enough money for a mortgage down payment. It’s especially hard when you’re struggling to make large student loan payments each month. 

Conventional loans, such as those backed by Freddie Mac and Fannie Mae, require a minimum payment of 20% or more of a home’s purchase price. For a $250,000 home (which is less than the current average single-family home), that’s a $50,000 initial payment. That amount is impossible for many people. This is especially true since buyers need enough cash at closing to cover appraisals, attorney and realtor fees, and other closing costs.

The federal government has made several programs available to make home buying easier. For example, loans insured by the Federal Housing Administration allow buyers to qualify for a mortgage with a down payment as low as 3.5% of a home’s purchase price. There are also payment assistance programs and other incentives available for first-time homebuyers.

Pros And Cons Of Federal Homebuyer Programs

The reduced down payment requirement is an obvious benefit of federal homebuyer programs. In addition, many government-insured loans, such as FHA loans, have relaxed requirements for credit ratings and debt-to-income ratios. This makes it easier for student borrowers to become homeowners.

There is a major downside to some federal programs, though. Many come with a list of rules that borrowers must follow to remain eligible. For example, a program may require you to remain in the home for a certain number of years without selling or refinancing. Or, it may require mortgage insurance payments for the life of the loan.

Rules, restrictions, and eligibility requirements are different for each homebuyer assistance program. It’s important to thoroughly research your options to find a program that will be a good fit now and in the future.

Student Loans Factor Into Your Debt-To-Income Ratio

Your debt-to-income ratio is one of the key numbers that mortgage lenders use to determine whether to approve or deny a mortgage application. This ratio is the percentage of your monthly income that you are already obligated to spend on debt payments. Lenders use this number to estimate how difficult it will be for you to make your mortgage payment each month. The rationale is that the more of your income you must pay on other debt obligations, the less will be available to pay your house note.

The magic number for mortgage loans is 43%. This is the highest DTI ratio you can have if you want to be approved for a qualified mortgage. If your ratio is higher, you may still qualify for a mortgage through a smaller mortgage broker. 

Mortgages with terms that deviate from the national qualifying standards aren’t eligible for backing by Freddie Mac or Fannie Mae. These mortgages might not offer the same protections and benefits as a traditional mortgage. If your ratio is higher than 50%, you likely won’t qualify for a mortgage from any lender.

Calculating Your Debt-To-Income Ratio

To calculate your debt ratio, add together all of your regular monthly debt payments, including: 

  • Monthly rent or mortgage payment

  • Student loan payments

  • Car note

  • Child support or alimony

  • Credit card payments

  • IRS installment payments

Use the minimum required monthly payment in your calculation. For example, if your student loan balance is $30,000 and your minimum payment is $250, use $250. Use $250 even if your actual payment each month is usually higher. Don’t include monthly expenses that are not debt-related, such as utilities, food, fuel, insurance, or retirement contributions.

After adding together your monthly debt payments, divide that number by your total monthly income. Use your gross monthly income, before taxes or other deductions are taken out. Multiply your result by 100 to determine your ratio as a percentage (for example, a result of 0.38 is 38%).

Improving Your DTI Ratio

If your calculated ratio is above 43%, meaning that you’re currently spending more than 43% of your gross monthly income on debt payments, you should work on reducing it before applying for a mortgage. It’s possible to improve your ratio even if you have large monthly minimum payments on your student loans. 

One way to improve your DTI ratio is to increase your monthly income. Try asking for a raise, going for a promotion, picking up more hours, or adding a side job to boost your income. Remember that any extra income needs to be steady, reliable, and documented to count toward calculating your debt ratio.

The other way to improve your DTI ratio is to reduce your monthly debt payments. Try to pay off smaller credit cards or other debts, so that you can eliminate one of your monthly debt payments. Consider consolidating or refinancing other debts, but only if doing so will lower your interest rate and minimum payments.

If high monthly student loan payments are the primary culprit behind your high debt ratio, you may be able to consolidate or refinance your student loans to reduce your monthly payment amount. Unfortunately, in most cases, you’ll need a fairly low debt ratio to refinance your student loans, making this option a bit of a catch-22. Alternatively, you may be eligible to enroll in an income-based repayment plan that reduces your monthly student loan minimum payment.

Refinancing Your Student Loans May Make It Easier To Get A Mortgage

Under some circumstances, refinancing your student loans could make it easier for you to qualify for a home loan. When you refinance student loans, a private lender pays off your existing student loan amount. You then pay the private lender back through a new loan with new financing terms.

The major benefit of refinancing student debt is getting better financing terms. This could mean a lower interest rate, lower payments, or a more favorable repayment plan. What counts as better terms depends on your circumstances and goals. In some situations, it could be to your advantage to opt for a short repayment term with larger payments that allows you to eliminate your debt faster and pay less in interest and financing charges overall. In other circumstances, you might be better off choosing a longer repayment period with a lower monthly payment, which would result in a lower DTI ratio.

On the flip side, not everyone qualifies to refinance student debt. Refinancing won’t help if you are struggling financially, have poor credit, or are in default on your loans. If your DTI ratio is high, you’ll likely need a cosigner to refinance your loans.

There are also drawbacks to refinancing your student loans. For example, a longer repayment period may lower your monthly payment. But you could end up paying more in overall interest and fees. It will also take you longer to pay off your loans. When you refinance with a private lender, you’ll give up many of the benefits and protections that accompany federal loans, such as emergency deferment and income-based repayment. Borrowers who are eligible for federal student loan forgiveness programs should be aware that refinancing their federal student loans disqualifies them for federal loan forgiveness. 

Student Loans Are Factored Into Your Credit Report And In Your Credit Score

Your credit history and score are also important factors in determining your chances of being approved for a mortgage. Both tend to be heavily influenced by student loan debt.

Your credit report is a statement of your past credit history. It contains a record of all your loans, debts, credit card debt, collection accounts, lawsuits, and other information. Your credit report will usually go back at least 7-10 years. You’re entitled to a free copy of all three reports once every 12 months (and are entitled to free reports more frequently during 2021 due to the Covid-19 pandemic). 

The information on your credit report is boiled down into a single number that lets lenders know how reliable or risky you are in terms of paying your debts. This number is your credit score. The most influential factors in computing your score include:

  • Your payment history, specifically, whether you tend to make your payments late or on time

  • Your credit utilization rate, which is the percentage of your available credit you’re using, or how close you are to your maximum balance

  • How long you’ve had your credit accounts

  • Whether you’ve recently applied for more credit

Your student loans are reported on your credit reports just like any other installment loan is. A car note is an example of an installment loan, which is paid back regularly, over time. The age of the loans and overall balance history affect your score, but your payment history is more important. Paying your loans on time each month and keeping your student debt out of default is a great way to improve your score.

It’s important to try to maintain a high credit score and a good credit history. Borrowers with good credit are more likely to get approved for mortgages, car loans, and other credit. They are also generally able to lock in lower interest rates than people with poor credit history. 

Let’s Summarize...

It’s possible to qualify for a mortgage even if you have a lot of student debt. Struggling with student loans, though, generally makes the process of qualifying for a mortgage loan more difficult. High student loan payments reduce your available monthly income. This makes it difficult to save a down payment. Large monthly payments can also affect your debt-to-income ratio, a key number that lenders consider. By paying your loans on time each month, you can improve your credit rating and increase your odds of qualifying for a home loan.



Written By:

Attorney Paige Hooper

LinkedIn

Paige Hooper is a seasoned consumer bankruptcy attorney with 15 years of experience successfully representing debtors in Chapter 7, Chapter 11 and Chapter 13 cases. Paige began practicing bankruptcy law in 2006 and started her own solo, multi-state bankruptcy practice in 2012. Gi... read more about Attorney Paige Hooper

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