Despite your confidence in your ability to complete a home loan application, you might doubt your ability to actually become a homeowner. This doubt rears its ugly head at the same time each month — the day you make your monthly student loan payment. That hefty monthly payment is already putting a squeeze on your finances, and adding another large debt might be too much for your income to handle.
While merely having student loans won’t prevent you from buying a home, a high balance can make it more challenging to get to the closing table. Here’s what you should know about how student loan debt might affect your ability to buy a home.
1. Your total student loan balance may be just as important as your minimum monthly payment amount.
Mortgage loan lenders will compare your income to either your total outstanding debt (including auto loans, student loans, credit cards, etc.) or your total minimum monthly payment on those debts to determine your debt-to-income (DTI) ratio. Each lender’s underwriting policies determine which figure or calculation is used for the comparison.
In either case, the less income you have to support your debt, the harder it will be to obtain a mortgage. Most lenders prefer your DTI to be less than 43%. A high student loan debt balance or minimum monthly payment could push you over the threshold.
2. Large student loan payments can prevent you from saving enough for a down payment and closing costs.
If a significant portion of your income is needed to make your student loan payments, you may have a little left over to save for a down payment and closing costs on a home. While you might be able to secure a house with a $0 down payment, you may still need to pay for some or all of the closing costs — which can be as much as 7% of the purchase price. Making student loan payments while attempting to save thousands of dollars for a down payment may mean you’ll need to delay homeownership for longer than you thought.
3. Late student loan payments can harm your credit score, which is another important factor in the home loan approval process.
If you’ve consistently made on-time payments to your student loan servicer and other creditors, congratulations! You’ve likely been rewarded with a healthy credit score. If you’ve missed a payment or two, however, that can negatively affect your credit score — a crucial factor in a home loan approval. Lenders look to your repayment history to gauge your ability to pay a mortgage. One missed payment from several years ago will have less of an effect on your credit score if it’s been followed by 24 recent on-time payments. But, late payments from a few years ago may still be lingering on your credit report.
Buying a Home While Making Student Loan Payments
Fortunately, there are actions you can take to increase your chances of mortgage loan approval.
1. Lower your DTI.
Since your DTI is based on your income and debt load, increasing your income or lowering your debt will improve your situation. Increase your income by taking a second job or creating a side hustle for yourself. You can use the extra funds to demonstrate you have the financial means to handle more debt, or use the funds to pay down your debt faster.
2. Pursue down payment assistance programs for your home loan.
Explore first-time homebuyer programs that offer down payment assistance if you meet specific requirements. If you’re a military veteran, you might qualify for a VA home loan. Or, if you plan on buying a home in a rural area, you might be eligible for a USDA home loan. Both of these loans allow qualified borrowers to purchase homes with no down payment.
3. Strengthen your credit.
Paying down your student loans not only increases your DTI, it can improve your credit score. The lower your credit utilization rate (the amount of credit used compared to the amount available), the better your credit score. You can reduce your credit utilization by paying down other debts. Continue to pay all your bills on time, since payment history and credit utilization are the two factors with the largest impact on your credit score.
4. Refinance your student loans.
Consider paying off multiple federal and private student loans* with one lower interest rate private loan to lower your minimum monthly payment amount and save on interest charges. This one action can free up cash in your budget allowing you to save more money toward a down payment and closing costs. Discovering how much you could save by refinancing is risk-free. Simply provide LendKey with a few details to quickly check your rate without affecting your credit score.
*Refinancing federal student loans with private student loans may cause you to lose eligibility for specific federal benefits like Public Student Loan Forgiveness.