How to Navigate Buying a Home with Student Loan Debt
People buy homes for various reasons. For some, it’s a way to build equity, while for others it’s an important life milestone. Although student loans can make buying a home challenging, it is not impossible. Below we’ll go over some of the home buying challenges student bowers face and ways to overcome them. After this read, you’ll be able to gauge whether purchasing a home is right for you.
How Loans Play a Factor in Buying a House
First, let’s take the time to understand how student loans can play a factor in the home buying process.
Unless you’ve got a couple hundred thousand dollars stored somewhere, you’ll likely have to take out a home loan. The first step in getting a mortgage is to get preapproval; this will help you understand how much house you can afford before committing to a loan. To get approved, mortgage lenders will look at five main factors: your debt, income, credit score, recent bank transactions, and any other assets you possess.
Student loans can sometimes serve as a challenge to meet these qualifications, as it affects your debt-to-income ratio, credit score, and the ability to save for a down payment. The ability to get a home loan will vary from person to person. Regardless of your situation, it’s important to understand the potential challenges you will face.
Debt & Income
Before deciding on a home, it’s important to assess your financial health. One of the best ways to understand your financial standing is by getting to know your debt-to-income ratio (DTI).
DTI is calculated by dividing your debts by your monthly gross salary. Start by listing all your recurring debt; this includes monthly car payments, credit card bills, student loans, etc. Once you add your debt together, divide that number by your pre-tax monthly income to get your DTI ratio.
Lenders look at DTI to make sure you’re not borrowing more than you can afford, as it allows lenders to see how much of your income is going towards paying off your debt. To qualify for a loan your DTI must be less than 43%, and ideally, your rent payment should make up less than 28% of your DTI. The lower it is, the better your chance of qualifying for the loan and a lower interest rate.
When it comes to DTI, no debt is weighed more than the other. However, because student loans can increase your total debt immensely, it can make your debt-to-income ratio less than ideal. There are two ways to improve your debt-to-income ratio: decrease your debt or increase your income.
First, see if there are ways to decrease your debt. Do this by increasing your monthly payments to pay off debt faster, not taking up any new debt, and lowering your credit card use. Paying off debt can be hard, however, with debt management you can figure out which debt to prioritize and different ways to decrease day-to-day expenditures to pay off your long-term debt sooner.
If you have the time and means, consider taking up a side hustle or finding ways to make passive income. You can also negotiate a higher salary or bonus. This will increase your monthly gross income and lower your DTI, assuming you keep your debts the same or lower.
Depending on how you’ve been managing it, student loans have the potential to boost your credit score, as it allows you to build and diversify your credit.
Like any big purchase, your credit score is a determinant of what loan you can qualify for and the interest rate you receive. Each loan has different credit score requirements. For instance, with a conventional loan, you need a minimum score of 620, but for an FHA loan, you only need a minimum score of 580.
To understand your credit score, you must understand what goes into it. Five main factors contribute to your credit score: payment history, accounts owed, length of credit history, new credit, and types of credit.
The most important factor is your payment history. When it comes to your student loans and other debt, do you pay the required minimum? Do you pay on time? If so, you’re good. If not, then you may have to make some adjustments or consider holding off on buying a home.
Consider setting up automatic payments for all your student loans and lines of credit to ensure you pay at least the minimum amount each month on time. If you want to increase your score quickly, then be strategic about how you pay your balances. Use less than 30% of your credit limit, pay off your balances twice per month, and if possible, try raising your credit limit. All this will help lower your credit utilization, which in turn, will boost your credit score.
Lenders look at credit scores to see how reliable you are as a borrower. Look at your credit report to understand your credit score. For better interest rates, shoot for a minimum score of 740 before buying a home. To best understand your report, consider getting a credit report review. It’ll help you remove any guesswork, check the accuracy, and improve your ability to create an action plan.
For many, the biggest mortgage obstacle isn’t qualifying for the loan, it’s saving enough for the down payment.
Down payment requirements vary for each loan type; many will say to have 20% of the house’s price saved for the payment. Paying 20% allows you to avoid paying for a PMI, qualify for better interest rates, lower your monthly payments, and get a competitive edge over other interested parties. Along with saving for the down payment, it’s important to save up money for other housing expenses such as closing costs, repairs, etc.
Create a financial goal. Know how much you need to save for your home’s down payment, then take that number and divide by 12 so you know how much to save each month. Having this hard number will give you a clear idea of your progress and help you stay on track to completing your goal. Consider getting a financial app to conveniently help organize and visualize your money objectives.
Start budgeting. List out all your expenses, including your monthly debts and any other expenses, such as groceries, gas, miscellaneous, etc. Make sure this list is as accurate as possible. Once you write your expenses, you’ll better visualize where your money is going and figure out opportunities where you can save. There are many ways to cut costs on everyday expenses. Carpooling, meal planning and cutting cable or streaming services are great ways to minimize unnecessary costs. This will help you save for a down payment while still being able to pay off your student debt.
When it comes to saving up for a home, people tend to follow the 28/36 rule. This rule suggests that no more than 28% of your gross monthly income should be used for housing expenses and that a maximum of 36% should be spent on other debts. To better understand how much money should be used to pay off your student debt, look to a student loan calculator.
If you’re a first-time home buyer, some programs may help you afford your down payment more efficiently. Look up the housing down payment assistance programs available in your area if you need assistance. Meeting with a CCCSMD Financial Advocate can help you identify and understand these programs.
Fixed-rate and conventional mortgages are the most common home loans, but for those with debt, it may be hard to reach the qualifications. Luckily, there are other mortgage options that are more practical for those with student debt.
An FHA loan is great for new home buyers that have student debt or low credit scores. They’re government-backed and have more lenient financial prerequisites and lower down payment requirements. However, these loans aren’t always attractive to sellers and may make it difficult to compete with other buyers.
If you’re a U.S. veteran or active service member, then a VA loan may be the best option for you. With a VA loan, you can buy a home with no down payment and get lower interest rates than other government-backed loans. This is perfect for veterans and service members that may have lingering student debt. However, there are strict service credentials you must meet to qualify.
A USDA loan is low-cost and has no down payment condition. It’s a great option for student borrowers that plan to move to rural or suburban areas. However, you must meet both the property and income eligibility provisions to get a USDA loan.
A home can serve as an opportunity to have and grow a family, build your dreams, or simply settle down in a place of your own. Everyone’s situation is different, take the time to assess your financial situation, understand potential challenges, and see if buying a home is right for you. Meeting with a Financial Advocate can help you make a plan to tackle your student loan debt and assess your readiness to buy a home. Call (800) 642-2227 for a free counseling session.