Trying to buy a home with student loan debt can seem daunting and maybe even hopeless, but it is definitely possible. In this article, we will go over some tips and techniques that will be helpful for those who have student debt, but also want to become a homeowner.
Understand Your Student Debt
Student debt can undoubtedly be crippling for some. Many are postponing home ownership because of their student debt. They believe that because they have student debt, they are unable to purchase a home. With a large amount of debt already accumulated and not yet paid off, how is it possible to get approved for a mortgage and take on even more debt? Well, it’s not impossible. There are many people who own homes and still have student debt and are not delinquent on their payments to both loans. The ability to get approved for a mortgage is based on three important factors:
- Your credit score
- Your down payment amount
- Your income in comparison to your debt
There are other factors associated with getting approved for a mortgage such as citizenship, but these are the three most important ones.
Why is credit score important?
Your credit score is very important to lenders because it shows them how responsible you are with your debt. Even if you have debt, you can still have good credit. Your credit score shows lenders if you are constantly late or if you always make your payments on time. It is important to know that getting your credit checked will lower your credit score. It is supposed to be like a savings account; it is something that you should maintain and improve, but not touch often. If you have a feeling that your credit score needs improvement, continue making your payments on time. Paying your bills on time and in full will help to boost your credit score and your financial reputation. There are multiple benefits to having a higher credit score, so if yours could use some improvement, it is in your best interest to do so before applying for a mortgage. Having a higher credit score will qualify you for more types of mortgages. This means that when it comes to buying a home, you will have more options on how to finance it. Having a higher credit score will also give you the benefit of getting a lower interest rate, which means that you will get to keep more of your hard earned money instead of using it to pay interest.
Why is your down payment important?
Like your credit score, your down payment amount could qualify you for different types of mortgages. Most mortgages require a down payment of at least 20% of the home’s selling price, but there are other mortgages that require less than that. For example, a FHA Loan requires that the borrower put down a minimum down payment of 3.5%, but because it is less than the traditional 20% down payment, the borrower is required to purchase FHA Mortgage Insurance. Conventional mortgages require 20% down, have lower interest rates, and don’t require the borrower to purchase mortgage insurance. Having a larger down payment gives you the liberty of having more choices and because different mortgage options also come with different interest rates, it is best that you qualify for as many as you can. In addition to increasing your options, having a larger down payment will simply help with your mortgage because the more you put down, the less you’ll have to pay each month. This will also help to improve your DTI (debt to income) ratio.
Debt to Income Ratio (DTI)
A debt to income ratio is the comparison of your household income to your household debt. While credit score is extremely important, your DTI ratio is probably even more important. This shows the lender if you are actually able to afford purchasing a home. A credit score basically shows the lender if you have a credit history and it shows how well you are at managing your debt. You can have a mountain of debt, but also have a great credit score. Because of this, your credit score isn’t the only thing that lenders look at in order to evaluate your financial situation. While this may make those with student debt nervous, the DTI ratio measures how well you would be able to afford your mortgage, regardless of whether or not you have student loan debt. To calculate your DTI ratio, add up all of your monthly bills. Include your student loan payment, rent, electricity and water and gas bills, credit card payments, etc. Take that number and divide it by your gross monthly income (the amount you earn BEFORE the taxes). The result is your DTI ratio and the lower the number, the better your situation will be.
How to Lower Your DTI
Your DTI ratio must be 43% or less in order to get approved for a mortgage because that is the highest a DTI ratio can be for a lender to issue out a loan. It is important to remember that if your result was higher than 43%, it is not the end of the world. The DTI ratio is calculated on your monthly financial obligations. If you have different types of student loans that have different interest rates that require different payment amounts, you could refinance them and get a lower interest rate. Because the interest with student loans are amortized, your monthly payment amount will decrease thus giving you a lower DTI ratio. If you have high interest credit cards, it is best to pay those off first. Many people don’t seem to realize that even if they have a relatively low balance, only paying the minimum payment amount each month will keep them in debt for years. Tackling debt with the highest interest rates are best because once the balance is paid off, it’ll free up more money to go towards other debt and pay those down faster. Reducing card balances will reduce the monthly payment amount, which will result in a lower DTI ratio.
Getting Pre-Qualified for a Mortgage
If you feel like you’re in good shape to buy a home, you can see if you pre-qualify for a mortgage. Getting pre-qualified is the first step in the mortgage process and helps you to focus on how you much you can afford. There is no commitment involved with pre-qualification. Many people get pre-approval and pre-qualification mixed up, but they are not the same and there is a difference between the two. Pre-qualification determines how much house you can afford and does not require you to provide all the documents related to your finances (these can be self-reported). Pre-qualification also does not require a credit check, nor does it require you to apply for a mortgage. These can also be online using mortgage pre-qualification calculators for those who do not want to communicate with a lender. While pre-qualification is a great tool used to gauge how much your loan amount can be, it is not guaranteed. These are estimates and approximations based on the provided information and since it does not require a credit report, the ending result can be different.
Getting Pre-Approved for a Mortgage
After going through pre-qualification, you can now get pre-approved for a mortgage. Pre-approval does require you to apply for a mortgage and will require a credit check and all the documentation required to prove your financial status such as pay stubs, bank statements, 2 years’ worth of tax forms, etc. If you end up getting approved for a mortgage, you are not obligated to commit. You are still able to get multiple pre-approval letters from different lenders before you make a choice. It is very important to note that even if you are pre-approved for a mortgage, it is not guaranteed that you will get the loan. This usually only happens if the real estate deal falls through, but most of the time it is due to changes in the financial situation that were made after the fact. Some of these changes include change in employment, changes made in the loan requirements, and taking on additional debt. When applying for a mortgage, it is important to not apply for any credit cards, apply for an auto loan to purchase a new card, or change jobs. Your approval is based on what was sent in and examined so it must stay the same or improve until you get the loan.
Overall Thoughts
Trying to take on more debt when you already have debt doesn’t sound like a situation that lenders would necessarily approve of, but thankfully the dream of owning a home is available to everyone. Improving your credit score and lowering your DTI ratio are some of the ways you can prove that you are capable of taking on even greater financial responsibility. So long as you are responsible and are able to manage your debt, home ownership is definitely possible for you.
