Student loan debt makes buying a home harder, but not impossible
Student loans impact your ability to buy a home
- Monthly student loan payments can take a bite out of your paycheck, making it hard to save for a down payment.
- Student loans increase your debt-to-income ratio, which makes it harder to secure and make payments on a mortgage.
- If your student loan debt gets out of control, and you can't make payments on time, this can damage your credit rating.
Many young people today are saddled with large amounts of student loan debt. It is not unusual for young professionals to have $20,000 to $40,000 or more in student loans, and those monthly student loan payments can take a large cut out of entry-level salary checks.
So, it is not surprising that many college graduates believe they cannot afford to purchase a home until either they find better jobs or pay off some debt. There is some truth to this, but it is important to know just how student loans affect your ability to buy a home so you can make informed decisions.
Student loans can adversely impact your ability to buy a home in three main ways. First, monthly loan payments can prevent you from saving money for a down payment. Second, student loan debt, on top of auto loans, credit card debt and other financial obligations, can raise your debt-to-income (DTI) ratio, which lenders consider when extending credit. Finally, student loans put an added strain on your finances, which can impact your credit rating if you begin to fall behind on payments.
To qualify for most conventional mortgages, you need a 20 percent down payment, so you will need $40,000 in savings to purchase a $200,000 home. There are programs for first-time homebuyers, such as Federal Housing Administration (FHA) loans, which decrease this percentage to as low as 3.5 percent (or $7,000 on a $200,000 home). Compare mortgage lenders to see what options are available to you.
These programs generally require mortgage insurance, which entails paying monthly premiums along with the mortgage payment. If a large chunk of your paycheck goes to paying off debt each month, it could take you years to get enough money for a down payment, especially in an expensive market.
Debt to income ratio
The DTI ratio is the percentage of your monthly income consumed by your debt burdens, including auto loans, credit card debt, student loans, private loans and mortgage payment. If more than a third of your income is going to pay off loan debts, you may have trouble qualifying for a mortgage.
Some mortgage programs allow a DTI ratio as high as 41 percent. If loan debt takes that much of your income every month, however, you may have trouble keeping up with your payments, and you could default on one or more of them, which will damage your credit rating.
How quickly you pay off your student loans can affect your credit rating, which can impact your ability to purchase a home (or to make any other large credit purchase). If you pay off your student loan too quickly, and have no other installment debt, such as a car loan, your credit rating could suffer — because lacking an installment loan affects your credit mix — which is a factor in calculating your credit score. Being late on your student loan payment also will adversely affect your credit score, so do whatever you must to make those payments on time (or a day or two before the due date).
Even worse is if you default on your student loan by not making any payments for several months. This will destroy your credit rating for years. In fact, a student loan default will remain on your credit rating for seven years — or longer in the case of some student loans — so even if you pay your bills on time during that period, the default event will still weigh down your score.
The best way to pay off a student loan is to make regular payments before the due date and to pay more than the minimum. This extra payment will go toward the principal of the loan and lower your DTI ratio over time, and such a payment pattern shows that you are a good credit risk.
Student loan deferments do not adversely affect your credit score, so if you are eligible for a deferment and are having trouble paying your loan, you should look into getting a deferment. Even better would be to refinance your student loan to a lower interest rate. Compare lenders to see if you can lower your monthly payment, which will lower your DTI ratio, making it easier to pay your bills — and maybe even allow you to begin building up your savings for a down payment on a new home.