If you’ve been following the news lately, student loan debt is a popular topic of discussion. Millions of Americans face the burdens of carrying tens to hundreds of thousands of dollars in student loan debt and for some, it has put a halt on the path to homeownership.
According to a 2017 report from the National Association of Realtors, 83 percent of non-homeowners polled in a survey say student loan debt is delaying them from buying a home. The report included that the median amount of student loan debt is $41,200 and when you compare apples to apples, that equates to more than a 20 percent down payment on a $200,000 home.
If you’re among those paying off student loans, you may be wondering if buying a home is even possible. The short answer is yes, depending on factors such as your personal financial situation, whether you have a reliable income stream, and the amount of debt that you owe.
“Buying a home when you have student loan debt isn’t impossible, you just need to understand that depending on your type of financing, the underwriting guidelines vary in regard to how this debit is evaluated and calculated,” said Jennifer Pack, a Loan Officer with Centier Bank.
Keep in mind that a mortgage payment isn’t the only thing that comes along with a new home, so the last thing you want to do is back yourself into a corner. If you’re paying off student loans and considering home ownership, below are some tips to keep in mind.
Work on improving your credit score, including paying your student loans on time
Your credit score is an important tool used to gauge your financial health, allowing lenders to determine whether you’re a risky borrower. Even if you owe thousands of dollars in student loans, you can still maintain a great credit score, and keeping your credit health in check could greatly enhance your chances of being approved for a home loan. Keep these tips in mind while building your credit score.
- Pay your bills on time: It goes without saying that making regular payments on time (even if it’s a minimum payment) and avoiding collections will serve you well. “Making payments on time, every time, is important to your credit health. If you don’t have a lot of credit history, student loans serve as an opportunity to build up credit,” Pack said. “It proves that you are a responsible borrower and that you are able to repay a loan.” Even though federal student loans are in forbearance until later this year, it may behoove you to make payments anyways if you’re able to. “Delinquency of student loan debt can adversely affect your overall credit rating and is hard to recover from,” said Pack. “Make sure you know when your deferment date ends and use auto payment and technology such as the online payment portal, to insure you have set up scheduled payments. Don’t rely simply on notice from the student loan lenders via mail, be proactive and create online access to all student loan accounts to ensure you are setting yourself up for success!”
- Use a mix of credit: If you’re still establishing a credit history, consider the different types of credit that make up your credit score. This includes revolving credit (such as credit cards) and installment loans (student loans, car payment, etc.). This provides insight as to how you handle your variety of debts. Just be sure to pay your credit cards off in full each month to avoid costly interest fees.
- Keep your credit utilization low: Just because a credit card company offers you a $10,000 line of credit doesn’t mean you should go on a shopping spree and max your card out, although nobody is stopping you. The general rule of thumb when it comes to lines of credit is to keep your credit utilization under 30 percent, though keeping it as low as possible or at zero is ideal.
- Don’t close old accounts: Maybe you recently paid off a credit card that’s been hanging over your head for quite some time. Congrats! But don’t close out that account. One of the factors that make up your credit score include the age of your accounts, and when you close out an account that you’ve had for several years, that takes that account out of the mix and can ultimately affect your credit score.
Work on bringing down your debt-to-income (DTI) ratio, including paying down your student loans
Unfamiliar with the term “debt-to-income ratio”? Essentially, your debt-to-income ratio is all of your minimum monthly debts divided by your gross monthly income. For example, if your gross monthly income is $5,000 and the minimum amount due on your monthly debts is $1,500, your debt-to-income ratio is 30 percent. If someone else is applying for a loan with you, be sure to include their income and debts as well.
In some cases, particular lenders will approve you for a loan with a debt-to-income ratio as high as 50 percent, but that’s not common. It’s usually recommended that you stay at or below 36 percent.
Some debts that SHOULD BE included in your DTI include:
- Student loan payments
- Rent payment
- Car payment
- Credit cards
Debts that SHOULD NOT BE included in your DTI include:
- Retirement contributions
When it comes to student loans, you need to consider how that particular debt will factor into your DTI. For example, if your DTI is substantially higher due to a hefty student loan payment, you may want to consider paying down some of that debt before taking on a home loan.
You may also want to check with your student loan lender to see if they offer an income-based repayment plan, where your student loan payment is calculated based off of your income. This could bring down your monthly payment substantially.
Apply for pre-approval and determine your budget
If you’ve done a deep dive into your finances and determined that your financial situation is stable and steady enough for a new home, the next step is to obtain a pre-approval letter from a lender. A pre-approval letter indicates that you are in good standing financially and estimates a monthly mortgage payment that best suits your budget.
When going through the pre-approval process, a lender will ask for documentation outlining your finances, including any student loan debt. Once you have this document, you’ll want to have a budget in mind that you know you can comfortably afford. As mentioned above, don’t forget that owning a home consists of more than just a mortgage payment.
Are student loans eating into your savings? Look into down payment assistance programs
When paying off student loans, coming up with several thousands of dollars for a down payment can be a stretch. The state of Indiana offers several down payment assistance programs based on particular needs. Those programs and what they have to offer can be found at https://www.in.gov/ihcda/4058.htm
Keep in mind that if you do put down less than 20 percent, some lenders will require you to carry Private Mortgage Insurance (PMI). PMI protects the lender if you default on your home loan. PMI premiums usually range from 0.5 to 1 percent of your annual mortgage payment and is included in your monthly mortgage payment. Once you’ve paid off 20 percent of your home, you’ll likely be allowed to drop PMI coverage.
For a more in depth breakdown, check out this infographic from MGIC Investment Corporation.