When Can I Buy a House If I Have Student Loans?
There are many reasons that millennials find owning a home appealing. In fact, a recent survey found that 33 percent of millennial home buyers’ decision to buy a home was driven chiefly by their dog.1 Dogs outranked marriage as well as the birth of a child as top motivators for buying homes. Whatever the case, becoming a homeowner is a goal for many recent graduates. But how does a home loan fit into the picture when you have student debt?
If you’re a recent graduate who’s ready to get out of a rental into your own home, there’s definitely a lot to consider, and luckily, lots of options as well.
Let’s explore some important financial considerations for potential homeowners, as well as some techniques recent graduates can use to prepare for purchasing a home.
Planning for Home Ownership with Student Loan Debt
Step One: Create a Graduated Savings Plan
One of the biggest hurdles to overcome before buying a house is saving for the down payment. The down payment is a large chunk of money, and the amount you can put into a down payment affects the rest of your mortgage. It’s especially not easy to save for a down payment when you’re already paying off student loans, but it can be done with some preparation. For one, you’ll need a graduated savings plan.2 This means that you can put most of your discretionary income towards debt while also saving the rest for a house. For this, you will need to create a timeline, and each year in the timeline, the proportions will start to reverse. This means you will pay less on your loans as they decrease and save towards the down payment on your home. The idea behind a graduated savings plan is that you put more money toward debt so that the eventual amount of interest is constantly reducing, thus contributing to your savings.
Step Two: Check Your Credit Score
You’ll also want to make sure your credit score is in good shape.3 This means paying your bills on time and managing your credit utilization. Some people think closing an old account is a great way to get a good credit score. In reality, an old account in good standing is useful towards improving your credit score. If you don’t have much to show in terms of credit, lenders won’t be able to make a decision about your future mortgage. One way to budget for this is to use a mix of revolving credit and installment loans to show that you can handle different types of debt.
Step Three: Get Your Debt-to-Income Ratio in Shape
Another key step in preparing to buy a home is knowing your debt-to-income ratio (DTI).4 Your DTI affects how much of a loan you will be offered and at what rate, and so you want to make sure your debt-to-income ratio is as low as possible.
Most mortgage lenders have a maximum of 43 percent DTI to qualify, so it’s important your DTI doesn’t exceed this. Typically there are two types of DTIs mortgage lenders look at. The front-end ratio shows what percentage of your income would go toward your housing expenses, including your monthly mortgage payment, real estate taxes, homeowner’s insurance, and association dues. The back-end ratio shows what portion of your income is needed to cover all of your monthly debt obligations, including your student loans. It’s easy to calculate your back-end DTI. Just take your monthly debt payments plus housing payments and divide this by your monthly income (before taxes and deductions).
Putting all these pieces together still may not yield a timeline you are happy with for home ownership that. You may want to consider student loan refinancing as a way to take more control of your debt and monthly budget, as well as to free up income to save toward a down payment, or even just to build up credit before applying for a mortgage.
Managing Home Loans and Student Loans
When buying a house, it’s important to manage both home loans and student loans. This is not easy, and so, before buying a home to take a look at your goals. Owning a home is a huge investment, and so if you aren’t sure where to settle down, or you simply want a “starter home”, then really consider whether homeownership is right for you at this time. If you are committed to a certain area and are looking to build your life within the community you’ve chosen, then homeownership might make sense. Still, you will have to be very careful to make all your loan payments in a timely manner.
Student loans are a long process for many, and understandably, not everyone wants to wait till they’re done paying off their student loans to move forward into the next phase of their lives. Unfortunately, the home-owning challenge doesn’t end with mortgage pre-approval. You will still need to be on top of your finances after you’ve realized the dream of homeownership. Here are some tips to keep your finances above the water:
Loan Consolidation or Refinancing
One option to ease the burden of student loans is consolidation. Loan consolidation essentially means combining multiple loans into just one loan. This results in a single monthly payment, and can sometimes lead to lower-than-current interest rates.
Loan consolidation can occur in one of two ways: either federally through the U.S. Department of Education’s Direct Loan Consolidation Program, or through a private lender (known then as refinancing). Refinancing before applying for a mortgage can be beneficial in that it will allow you to make one monthly payment towards your student loans as opposed to managing many, and often yields a lower interest rate. Secondly, there are a number of down payment assistance programs that are acceptable to lenders. Many states and cities offer down payment assistance programs that allow you to sweat equity if you want to build a new home.
Using Your Home as An Investment
Apart from the intangible benefits of homeownership – like having a place to call your own, furnishing your space the way you want without having to worry about renter agreements and more – there are also measurable benefits to owning a home.5 The largest measurable benefit would be price appreciation.
Price appreciation is what helps build home equity, which is the difference between the market price of the house and the remaining mortgage payments. Even though building equity does not directly help you pay off student loans, it does help you in the long run and increases your asset value.
The Office of Federal Housing Enterprise Oversight (OFHEO) website also has tools for estimating the value of a home based on average rates of appreciation. Price appreciation depends a lot on the location of your home. Thus, it is wise to study demographic and economic trends in the area you plan to buy a home in, especially if you have many choices. You could also view your home as a money-making tool, especially if it is in a prime location. If you get a roommate or rent a room out on AirBnB, this will generate income that could help you pay the mortgage or put the money toward your loans.
Like any big goal in life, home owning while still paying off student loans is all about balance. Make sure to review your priorities and consider how buying a home may affect you in the long-term. If everything makes sense to you, then there’s no harm in deciding to buy a home even when you have student debt.