Most Americans still view homeownership as a key to building wealth, but for many, that piece of the American dream is on hold or out of reach thanks to the heavy burden of student debt.
In fact, according to a recent study, millennials currently struggle with so much debt that 25% worry they won’t qualify for a mortgage. Nearly 1 in 5 millennials (19%) think their credit card debt will be a stumbling block when applying for a mortgage, while 1 in 7 (14%) think the same about their student loans.
If you’re considering buying a home but worry that student debt will prevent you from securing a mortgage, you’ll need to be strategic about your approach to increase the probability of your application getting approved.
How student loans impact your ability to buy a home
Adding a mortgage on top of monthly student loan payments can create a significant financial strain. The more debt you carry, the fewer resources you have to allocate toward a down payment or for monthly mortgage payments, making some lenders less likely to approve your application. Student loan debt may affect your home-buying goals in a few key ways.
Debt-to-income ratio (DTI)
Lenders calculate your DTI ratio by dividing your total monthly debt payments (including student loans) by your gross monthly income to assess your ability to handle additional debt, like a mortgage. Having a high debt-to-income ratio can limit the loan amount you qualify for, or even disqualify you from certain mortgages. DTI standards vary among lenders, but most look for a DTI below 35%, while others accept up to 45%, and still others, like an FHA-backed loan, will allow 50%.
Credit score
Your credit score reflects your approach to handling credit and gives lenders insight into how likely you are to make timely payments. A higher credit score is generally associated with high reliability, improving your chances of a mortgage approval. A lower credit score due to late payments or defaults may pose more challenges to getting approved.
Ability to save for a down payment
Having a larger down payment will reduce the amount you need to borrow and can strengthen your mortgage application. Student loans, however, can make it harder to reach that down payment goal. Showing lenders you have a stable income large enough to handle both mortgage and student loan payments is a plus.
Strategies for securing a mortgage with student loan debt
Student loan debt is just one factor lenders use to determine if you qualify for a loan. To improve your chances of getting approved, consider the following strategies.
Pay down your debt
Work to reduce your overall debt and improve your debt-to-income ratio by paying down high-interest debts first (like credit cards), and explore options for refinancing or consolidating student loans and other debt to make monthly payments more manageable. In addition, you might also explore strategies like using a “debt avalanche” to pay off high-interest loans quickly.
Improve your credit score
Boost your overall credit score to improve your chances of getting more favorable mortgage terms. It’s important to make consistent, on-time payments on all your debts, including student loans and credit cards, as even one late payment may be reflected in your credit report.
Review your credit report at least annually to check for discrepancies and address any errors promptly. If you’re struggling to bring your credit score up, consider credit counseling as an option for in-depth advice.
Switch to an income-driven repayment plan
You might qualify for one of the federal government’s four income-driven repayment plans (IDRs) based on your current circumstances. IDRs are intended to make student loan debt more manageable by calculating a monthly payment based on your current income and family size, rather than the amount of your debt.
While an IDR can significantly reduce your monthly student loan payment, thereby freeing up more money for a mortgage payment, there are some potential downsides, including the fact that you’ll pay more interest on your student loan over the long haul. Weigh your options carefully, and seek professional advice if necessary before applying for an IDR.
Shop around
Do your homework and compare the competition. Choose a reputable lender who has experience working with clients who carry student loan debt, as they’ll be able to help structure the best financing options to suit your specific needs. Consider getting pre-approved if possible, as this not only gives you a realistic idea of how much you’ll be able to borrow, but it also signals to home sellers that you’re serious rather than casually looking.
Add a co-signer
If you have a responsible family member, or trusted friend, on solid financial footing with little debt and a high credit score willing to co-sign your mortgage application, you could improve your chances of getting approved. For this kind of agreement to work, it’s advisable to work with an attorney so terms and conditions are clear within a written contract that includes repayment schedules and title agreements.
Consider home loan programs
There are a number of home loan programs you may qualify for, even if you carry student loan debt.
Fannie Mae and Freddie Mac both have a number of loans that cater to lower-income borrowers or first-time home buyers and may accommodate low down payments and cancellable mortgage insurance, among other features.
Other government-backed loan programs include FHA loans which typically require only a 3.5% down payment, as well as VA loans for active-duty service members, surviving spouses, and veterans, which do not require a down payment or mortgage insurance. USDA loans may be available if you live in a designated rural area.
Work with a lender who is knowledgeable about your particular situation and can recommend a loan program to meet your needs.
Buying a home with student debt can be challenging, but it’s not impossible. Work closely with both a real estate professional and a reputable lender to create a strategy that will meet you where you are, and open the door to your new home sooner.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.
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