If you’re considering a home purchase, first ask yourself if you’re on strong financial footing and ready to commit. Many young would-be homeowners are struggling to answer this question while burdened with student loan debt. Affecting more than 40 million Americans, millennials, in particular, are feeling the weight. For previous generations, being able to buy a home was seen as an important step to adulthood. But study after study shows that today’s young adults are delaying homeownership often because of overwhelming debt. So let’s take a look at some of the ways student loans can affect your ability to get a mortgage.
Student Loans and Debt-to-Income Ratios
At its core, a debt-to-income ratio is exactly that: a comparison between the amount of debt you have versus the amount of money you make. DTI is one of the most important factors a bank will consider when buyers are applying for a mortgage because it helps lenders evaluate both how much more debt you can handle and how much of a risk you pose. Everyone has a DTI ratio, but the lower yours is, the better chance you have of being approved for a mortgage. As a general rule of thumb, 36% is ideal for most people.
If you are in deferment, lenders will still consider student loan debt against your DTI ratio because they know you will eventually begin paying off that loan again. Having an affordable mortgage for the 6 or 12 months you are in deferment is great – until you are paying student loan payments too and it’s suddenly a burden.
Your Credit Score
Your student loans count against your DTI but also influence your credit score since they are reported on a credit report just like any other payment obligation. Paying loans on time is a great way to build your credit and maintain a strong credit score. Late or missed payments as well as defaulting on a loan can weaken it. Most lenders consider FICO scores of 740 or higher to be strong, but if your score is under 640, it will be difficult to qualify for a mortgage without paying high interest rates. If your score is under 620, you may have a hard time qualifying for a mortgage at all.
Bear in mind also that lenders don’t use your highest score. They will take the middle score from three sources — Equifax, TransUnion, Experian — to qualify you for your mortgage. Applying with a partner? The lender will take both your middle scores and then use the lowest between the two.
Paying Off Loans vs. Buying a Home
If you’ve got some money saved up, you may be wondering if it’s better to pay off your student loans or to buy a home. If you have high interest loans, it may be advantageous to pay them off or to refinance your loans to a better rate before buying a house. If you have low interest student loans already, consider putting your savings down for a house. If you have a larger down payment, the lender is more likely to be generous with the interest rate on your loan because the lower your loan amount, the less risk to the bank. Just like with student loans though, make sure that you can make your monthly payments long term.
What You Can Do About Student Loan Debt
You can improve your DTI ratio by bringing in more income each month, perhaps by taking on freelance work or a second job. Consolidating your student loans into one loan with a lower payment will reduce your debt obligation and strengthen your DTI ratio. Also look at reducing your other monthly debt such as credit card bills, car payments and more. In some cases, student loans can be forgiven, canceled or discharged through public service or teaching. For a full breakdown of the ways this can happen, visit the Department of Education’s Forgiveness, Cancellation, and Discharge Program.
If you have questions about how to be better prepared for anything that might affect your home and mortgage, Capital City Home Loans is here to help you. Our goal is to be a true partner and advisor, providing exemplary service from the first conversation to well beyond the closing table. Capital City Home Loans is a full-service lender, offering a suite of mortgage program options like FHA, VA, conventional, jumbo and portfolio products. By offering a growing inventory of mortgage finance products and empowering our associates to help each and every client choose the best options, we are focused on being the best and strongest lender in the Southeast. Please contact us here. We look forward to assisting you!
