Monday, 26 October 2020

Buying a House When You Have Student Loan Debt

Buying a House When You Have Student Loan Debt
28 May
2:29

Buying a House When You Have Student Loan Debt

Buying a House When You Have Student Loan Debt

Student loan debt stands in the way of homeownership for many would-be buyers, even decades after they graduate college. The outstanding student loan debt balance across the U.S. has ballooned to $1.49 trillion, and today’s typical college graduate walks across the stage with a $30,000 bill following close behind them.
Fortunately, student debt doesn’t have to be a deal-breaker for your homebuying aspirations. But there’s no getting around the fact that a large student loan balance will certainly influence how much financing a mortgage lender is willing to offer you.

Can you get a mortgage while repaying student loan debt?

The short answer is yes, you can — but it depends on how much you owe, your monthly student loan payment and how much income you bring in every month.

Lenders take a hard look at how all of your outstanding debt — from car loans to credit cards — comares to your monthly income. If your student loan payment takes up a significant chunk of your paycheck, you likely wouldn’t qualify for a mortgage. However, if your student loan payment is manageable and you still have enough room in your budget to comfortably make monthly mortgage payments, you may qualify for a home loan.

Your outstanding student loan debt typically appears on your credit report under the installment loan category. Once your student loans go into repayment, you’re usually given a fixed monthly payment amount and a predetermined term over which to repay the money you borrowed.

Next, we’ll go a little more in-depth about how your mortgage lender will evaluate your student loan debt.

How mortgage lenders view student loan debt

When evaluating whether you qualify to borrow a mortgage, lenders must determine your ability to repay the loan. One primary way they do this is by calculating your debt-to-income (DTI) ratio. This is the percentage of your pre-tax monthly income that goes toward repaying debt, including auto loans, credit cards, personal loans and student loans.

In most cases, mortgage lenders expect your debt-to-income ratio to be at or below 43%. This calculation includes all of your monthly debt payments, including your student loans. The DTI ratio also considers your estimated future monthly mortgage payment.

Here’s how to calculate your DTI ratio. Let’s say you have a $60,000 salary, meaning your gross monthly income is $5,000. Your monthly debt payments break down in the following way:

Debt Type

Monthly Payment Amount

Auto loan payment

$300

Credit card payment

$250

Student loan payment

$400

Estimated mortgage payment

$1,100

Total

$2,050

You would divide the total number of your monthly bills ($2,050) by your gross monthly income ($5,000) to arrive at a DTI ratio of 41%.

Calculating your monthly student loan payment

Your lender has a few options when evaluating your monthly student loan obligation, depending on its status when you apply for a mortgage:

Monthly payment amount

If you are currently in repayment on your student loans and make a regular monthly payment, whether it’s a standard or income-driven repayment plan, information about your loan balance and monthly payment amount will more than likely show on your credit report. In this case, your mortgage lender can use the payment amount shown on your credit report.

Income-based repayment

If you are on an income-driven repayment plan, which sets your monthly student loan payment amount based on your income and family size, your payment may have been set to $0 for the time being. If this is the case, there are a few ways your lender can calculate what your monthly student loan obligation is:

  • Verify the payment amount with supporting documentation and use the $0 monthly payment for loan qualification purposes. This applies to mortgages that are eligible to be purchased by Fannie Mae.
  • Use 0.5% of the outstanding loan balance to calculate a monthly payment amount. This applies to mortgages that are eligible to be purchased by Freddie Mac.

Deferment or forbearance

In the event that your student loans are in deferment or forbearance, that means you temporarily suspend your student loan payments or significantly reduce the monthly amount you pay. The difference between deferment and forbearance is whether or not you’re responsible for paying the interest that accrues on your loans during the period your payments are postponed or reduced.

In either of these cases, mortgage lenders must either use 1% of the outstanding loan balance to calculate a monthly payment amount, or the payment shown on your credit report.

How to qualify for a mortgage if you have student debt

As we’ve discovered, it’s possible to qualify for a mortgage if you have student loan debt, but what makes or breaks your approval decision is how your monthly student loan payments factor into your overall debt load. Below are some actionable tips to help you realize your homeownership dream while carrying student loan debt.

Buy a house below your means

There’s no need to buy a house that is priced at the maximum amount you can afford, especially if you barely qualify for a mortgage to purchase a home at that price tag. Try buying a home that costs significantly lower than what you can reasonably afford.

If you received a mortgage preapproval (a letter from a lender saying you’re conditionally eligible to borrow a certain amount) for $200,000, shop for homes that cost $150,000 or less to give yourself more cushion to comfortably repay your mortgage, student loans and other forms of debt.

Use our home affordability calculator to get an idea of the maximum home price you can afford and remember to aim lower.

If the more affordable homes in your area look more like fixer-uppers and less like move-in ready properties, ask each lender you speak about their available options for adding construction costs to your mortgage.

Refinance your student loans

You may be able to lower your the interest rate and monthly payment amount on your student loans through refinancing.

Let’s say the outstanding balance on your federal student loan is $30,000 at a rate of 7.5%, assuming a 10-year repayment schedule. The total monthly payment would be $356.11 per month. What if you refinanced the same student loan, dropped the rate to 6%, and extended the term to 20 years? The new monthly payment would drop to $214.93 per month. That’s a monthly savings of $141.18.

There are, of course, pros and cons when it comes to refinancing student loans. If you have federal loan debt and you refinance with a private lender, you’re losing all the federal repayment protections that come with federal student loans. On the other hand, your options to refinance to a lower rate by consolidating federal loans aren’t that great either. Student debt consolidation loan rates are rarely much better, as they are simply an average of your existing loan rates.

Apply for an income-driven repayment plan

If you’re on a standard 10-year student loan repayment plan and your monthly payment amount eats up a large chunk of your income, you may want to apply for an income-driven repayment plan. Keep in mind this option only applies to federal student loan borrowers.

There are four available income-driven repayment plans:

  • Income-Based Repayment: 10% or 15% of your discretionary income, depending on when you first borrowed your loans. Repayment is 20 or 25 years depending on your initial borrowing date.
  • Income-Contingent Repayment: The lesser of 20% of your discretionary income or the fixed amount you would pay over a 12-year repayment plan, adjusted according to your income. Repayment period is 25 years.
  • Pay As You Earn: 10% of your discretionary income, but no more than the 10-year standard repayment plan amount. Repayment period is 20 years.
  • Revised Pay As You Earn: 10% of your discretionary income. Repayment period is 20 years for undergraduate loans and 25 years for graduate loans.

Eliminate your non-educational debt before applying for a mortgage

Improve your chances at mortgage approval by paying down or paying off your other debt — whether its an auto loan, credit cards or some other loan or line of credit — in the years or months before you decide to apply for a home loan. Doing this can help reduce the percentage of your debt-to-income ratio, especially if you’re getting rid of revolving debt such as a credit card.

Keep in mind that a large credit card debt balance will hurt your credit score more than a large student loan debt balance, according to FICO, the creator of the FICO credit scoring system. That’s because carrying a large student loan balance doesn’t stand in the way of you achieving a high score — as long as you’re repaying the loan on time. However, carrying a high balance on your credit cards relative to your credit limit negatively impacts your score, as it shows you’re using too much of your available credit and indicates to lenders that you’re a high-risk borrower who may have trouble repaying a mortgage.

There’s a mortgage lending “loophole” you can take advantage of. A mortgage lender is allowed to omit any installment loan that has less than 10 payments remaining. So if you have an auto or personal loan with less than 10 payments left, the mortgage lender will remove these from your monthly obligations. In our hypothetical case above, this would give you an additional $300 per month of purchasing power.

Consider a cosigner

Some might not like this idea and it should be an absolute last resort, but you can ask mom or dad to cosign for you on the purchase of the house. But there are a few things you want to make sure of before moving forward with this scenario.

First, do your parents intend to purchase a new home in the near future? If so, make sure you speak with a mortgage lender prior to moving forward with this idea to make sure they would still qualify for both home purchases. Second, be mindful that the only way to get your parents off the loan would be to refinance that mortgage. There will be closing costs associated with refinancing your mortgage and you’ll still need to meet credit and income qualifications.

The bottom line

Your student loan debt doesn’t have to be the reason you count yourself out of buying a home. If you believe there’s some extra work needed on your end before you apply for a mortgage, start preparing for the process at least a year ahead of time. And don’t be afraid to allow a mortgage lender to run your credit and do a thorough analysis so you know where you stand and what you should work toward.

A credit inquiry can temporarily drop your credit score by a few points, but it’s worth the risk. You’ll have time to recover those points and then some.

When you’re finally ready to buy a home, keep your lender rate shopping period within a short time frame to minimize the risk to your credit score. Older FICO scores recognize a 14-day shopping period and newer scores have a 45-day period. All inquiries made within the designated time frame are treated as just one inquiry, according to FICO.

You should also compare rates on the same day if at all possible, as it’s the best way to make a true “apples-to-apples” comparison. Finally, always request an itemization of the fees to go along with each rate quote.

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Crissinda Ponder

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