The current generation of home buyers – or at least people who want to buy in the near future – have more student loan debt than ever before. Most are renting well into their late 20s and 30s because they are unable to save for a down payment and other closing costs. And even if they are able to save, it still begs the question,”Can I buy a house with student loan debt?”
Student loans are like a few extra pounds – easy to gain quickly and only seem to go away after you’ve been working on them forever. So, what do those loans mean when you want to buy a house? Can you buy a house with student loan debt? In most cases, yes. But before you start Googling realtors in your area, keep in mind that just because you CAN buy a house with student loans doesn’t mean it’s in your best interest.
With debt, the more of it you have, the harder it can be to take on – and manage – new ones. Simply put, you’ll want to pay off one debt before going into another.
Although we live in a society that says consumer debt is normal and ok, it doesn’t change the fact that carrying too much of it can hurt your chances of getting a good deal on a home, or buying a home at all. Your debt to income ratio is a major factor here.
Debt to Income Ratio – Or DTI
What exactly is a debt to income ratio? It is essentially a number that lenders will assign your application, based on your personal income and debt factors. The higher debt and lower income you have, the higher your debt to income ratio will be. And in this case, a high score isn’t going to put you at the front of the class!
Let’s break this down – if you have $48,000, your monthly gross income would be $4,000. Now let’s say you have the following payments (debt) every month:
Car Loan – $300
Credit Cards – $200
Student Loans – $375
If you add those payments up (to get $875) and divide them by your monthly income of $4,000, you should get a DTI of about 22%. That’s not too bad, right? But hold on, we haven’t calculated your new house payment, which the lender is definitely going to account for.
Let’s say you plan to have an all-in house payment of $1,200 and we rerun the calculation, this time starting with payments of $2,075. Your DTI just jumped to 52%, which is well over the maximum allowed by most lenders.
What should be your DTI goal?
So, what number should you be aiming for? Most conventional lenders want to see you at 36% or below. In our scenario above, let’s say you had paid off your car and student loans before applying for a new home. That would leave you with just $1,400 in payments, giving you a debt to income ratio of 35%.
If you decide to pursue an FHA loan, you may be able to get away with a higher DTI, typically 43%. In this case, if you kept your car loan and credit cards but had paid off your student loans you could just scrape by at 42.5%.
Buying a home with student loans is not impossible, but as you can see from our example, it will make it really difficult to meet the guidelines. This is because student loans are typically a significant expense, and they’re around for a long time if you don’t work to pay them off early.
Save money or pay off your student loans?
Another challenge you’ll run into when buying a house with student loans starts well before you have your first payment. And that’s your ability to save while making payments to your student loan provider. If you have a large payment, for a long period of time, it can be difficult to have extra money to set aside. But unfortunately, you’ll need a lot of extra money to go into the home buying process for things like closing costs, down payments and moving expenses.
So, what is the punchline? Give up and go home? Absolutely not! We’re in the business of helping you buy your first home. Here’s what you need to know – paying off your student loans will take patience and determination, but you can do it. And once you do, it will be a huge step forward towards buying your first home.
And here’s more good news. When you do get into that house, it won’t be nearly as stressful because you’ll only have to worry about your mortgage payment! Student loan payments will be a thing of the past instead of trying to balance what may feel like two house payments at once.
If you have student loans and it’s time to address them, we’re here to support you! Besides working on a budget and picking up extra work or starting a side hustle, consider refinancing. Although this isn’t the best option for everyone, refinancing could be a way for you to get your DTI down faster.
Refinancing your student loans
Here’s what you’ll want to consider when refinancing – your terms, the overall savings and the fact that in some cases you may be moving your loans from government-backed to private, which means certain features of your loan no longer apply. For example, it could make you ineligible for government assistance programs designed to pay off student loans. Be sure to understand ALL the implications before you make any decisions.
So, does it matter if you’re only a few years away from paying off your loans if you have money to spare? It could! You may be able to take that extra money and negotiate a settlement instead of continuing to pay your loans off over time.
Depending on what type of loans you have (private or Federal), you may be able to pay off the remaining years early – and for less money overall. You could also negotiate to pay less due to income or hardship situations.
Whatever you do, don’t default
Talk to your lender before you go into default and explain your personal circumstances. If your income has dropped or remained low, you may be eligible to pay less on a monthly basis. You could also stop payments altogether if your lender allows you to take advantage of deferment.
Settling your student loan debt
If you owe $5,000 and you have some money set aside close to that amount, call your lender and ask them what it would take to get the job done. Experts advise allowing them to say a number first, rather than starting negotiations yourself. They may start out lower than you would have initially offered!
Be honest with yourself
Keep in mind that all these options, including refinancing, can play a role in your home buying process. The best thing to do in any circumstance is to take a moment and be honest with yourself.
- Can you REALLY afford a mortgage AND the money you’ll need for closing costs, a down payment and all the other fees associated with a home purchase?
- If you can, will you still have savings set aside for emergencies and unexpected expenses that may come up after you close?
- If you were able to defer your student loan payments for a period of time, would you still be in good shape when you have to start paying them again?
A home is not a short-term purchase and the goal should never be to sacrifice everything and make it work initially, at the expense of your long-term success. Be realistic about your future and make decisions that will be best for you, not only this year, but also in the next five and ten years.
If you absolutely can’t wait to get yourself into a home, with existing student loans, is it possible? That depends on you!
Here are the factors you’ll need to focus on if you’ve decided to move forward:
Your Credit Score
Even with a great debt to income ratio, your chances of getting into a home won’t be as good if you have a bad credit score. It’s not just how much you owe in student loan payments, but also how consistent you are with paying them. Keep in mind that every late payment, to student loans and other bills, could negatively affect your score, and your home buying dreams. As you begin the home buying process, take a moment to evaluate your credit and do what you can to start making improvements.
Take into account all the factors your lender will consider and work simultaneously on what you can control. Don’t decide to stop making payments on your student loans, for example, hoping that will force your lender into negotiating. You could inadvertently get rid of one problem while creating another!
More on your Debt to Income ratio
By now you probably understand how significant your debt to income ratio is. Take the time to run different scenarios with your own situation, as we did above. If you can’t pay off your student loans before you plan to buy a home, focus on smaller debts like credit cards or medical bills.
Understand how your debt to income ratio changes based on the decisions you make and act accordingly. Keep in mind that it’s not just debt that plays a role here. It’s a debt to INCOME ratio, so if increasing your income is an option, make sure you’re working on that too.
Going back to our original example, a person making $4,000 a month with $2,075 in payments has a DTI of 52%. If that same person made $5,000 a month, their DTI would drop to 42%, below the number required for FHA lenders. It’s not to say paying off debt isn’t important for a lot of reasons, but increasing your income is always a good plan too.
Move at your own pace
At the end of the day, we want to see you in your first home. But simply getting there isn’t the only goal. It’s also setting yourself up to enjoy the experience of homeownership rather than risking everything to get there. You have your whole life to be a homeowner so don’t rush into it before you’re ready. Focus on what is in your control and take steps forward whenever possible.
We work with all the experts you’ll need during your home buying process, but even before that, we’ve developed plans to help you get ready. Whether it’s educational materials or a savings plan to put in place now, we are your cheerleaders on this journey. Let’s get you ready so you can get the keys to your dream home sooner rather than later!
