The Skinny on How to Buy a House with Student Loan Debt:
You can do it, but here’s what you need to know!
Have student loan debt? Still want to buy a house with student loan debt? You’re not alone! These days, more than 54% of college attendees take on debt to go to college. The average debt for a 2016 graduate tops $37,000! In 2019, outstanding student loan debt reached an all-time high of $1.41 trillion. In cities like Arlington, Alexandria, and Bethesda, average student debt is far above this average.
While such debt is considered “good” debt, it can have a significant impact on the budgets and goals of these twenty-somethings. If you have outstanding educational debts and hope to buy a home soon, be advised of some recent — and important — changes in how your student loan payments affect your mortgage prequalification. Here is the skinny on how to buy a house with student loan debt.
Alternatively, we have some tips on how you can get approved for a mortgage if you’d like to take a look at that as well.
First Things First
When applying for a mortgage, your lender will calculate a front-end debt-to-income (DTI) ratio of all housing expenses (such as mortgage payments, mortgage insurance, etc.) divided by gross income. They will also look at your back-end DTI which calculates the percentage of gross income going towards all other types of debt like credit card debt, car loans, loans for furniture or jewelry (engagement rings) and yes, student loans.
While not set in stone, lenders want your monthly housing costs to be at or below 28% of pre-tax income before taxes. Lenders typically require a back-end ratio of 36% or less.
Recent Changes to How Your Loans Affect Your Qualifications
Government-sponsored Fannie Mae, which owns or insures nearly half of the US mortgage market (along with Freddie Mac), recently made significant changes in their guidelines for how student loans are calculated for purposes of qualifying for a mortgage. The FHA and VA have also changed their guidelines. This is why it is so critical to select a reputable lender. We’ve seen lenders who did not know about the changes and mistakenly qualified buyers for more of a mortgage than they could afford once the new changes took place. This created a huge let down when they ultimately learned they did not qualify for as much as they thought they would be.
Using Student Loans to Calculate Your Ratio & Mortgage Qualifications
Fannie Mae and FHA Loans: The monthly student loan payment considered for qualifying purposes towards your back-end ratio will be 1% of the total outstanding balance of the loan or the payment reflected on the credit report – whichever is more.
For example, if your monthly student loan payment is $350, it’s logical to think that amount will be added to your monthly debts when calculating your back end ratio. However, if you have total student loan debt of $50,000, your lender must now use 1%, ($500) of that amount in the DTI ratio, since it is the greater of these two numbers.
Freddie Mac: Freddie Mac has not changed their guidelines. If a monthly payment reflected on the credit report, then that is the payment used for qualifying for a mortgage.
VA Loans: For VA loans, the monthly student loan payment used is the greater of ½% of the outstanding balance of the loan divided by 12 (a much more lenient calculation) or the payment reflected on the credit report.
Using the example above of a $50,000 student loans, this amount would translate to roughly $21 added to the back end ratio. Of course, if your actual monthly payment is higher, that number would be used.
How Can I Improve My Ratio & Qualifications?
If you do carry significant student loans and are seeking to buy a house with student loan debt, fret not! There are things you can do to improve your situation:
- Check your credit report ASAP
- Work to improve your credit score
- Decrease your debt-to-income (DTI) ratio
- Get pre-approval and know your homebuying power
- Consider down payment assistance programs
Be Sure You’re Ready
All this said, before you buy a home (and take on another significant debt), make sure you’re truly ready. Are you comfortable carrying two such debts over long periods of time? Are you confident about your income and future earning potential? Will you be able to comfortably afford a mortgage payment on top of your student loans?
Also, review your lifestyle and priorities. Will a mortgage AND student loans require you to cut back on your retirement contributions or other areas of your life? Will you have to scale back on travel or entertainment? Consider what matters most to you, and plan accordingly. We are always happy to help you explore all of these questions.
The Bottom Line
Confusing? We know! Our best advice to buy a house with student loan debt? Meet with a reputable, local lender early in the process to avoid surprises (we have several excellent recommendations). And of course, use a trusted and experienced Realtor to guide you through the home buying process. Contact us today if we can help!
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