For many aspiring adults, having your own home is like a dream come true. So, if you have a high-paying job and a good grasp of your overall finances, you may be considering getting your own place. But over 34% of all adults aged between 18 and 29 years have some kind of student debt which can significantly influence their ability to get a mortgage approved. So, is it a good idea to apply for a mortgage if you already have student loans pending? We’ll explain how lenders perceive this type of debt and offer some helpful advice on how to increase your chances of qualifying for a mortgage loan.
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Lenders’ Perspectives on a Mortgage Loan
Having student debt is not the end of the world, and to buy a home or qualify for a mortgage, you don’t have to be completely debt-free. However, your existing debt, especially related to your outstanding student loans, is one of the most critical factors lenders assess when considering you for a loan. Lenders must be completely assured that they have the financial means to make regular payments to pay off the loan in due time. Some of the things that lenders are most interested in when considering your mortgage application while having an outstanding student loan are:
Debt-To-Income Ratio
When considering you for a loan, lenders look at the debt-to-income (DTI) ratio. The percentage of your monthly income that goes toward debt is referred to as your DTI ratio. If your DTI ratio is too high, you can have problems securing a mortgage as you are perceived as a high-risk individual in the eyes of the lender. Having a high DTI score also means you are more likely to fall behind your expenses and fail to pay off your loan payments on time.
What is considered a good credit score can vary drastically from lender to lender, but as a rule of thumb, you should always try to have a DTI score of below 50%.
To calculate your DTI ratio, first, add all the monthly payments that you have on a fixed basis and divide it by your monthly pre-tax income. You should only consider regular, recurring, and required payments in your calculations and leave out any variable expenses like food and utility bills.
Some of the most common expenses that you should consider are:
- Your rent or mortgage payment
- The cost of your homeowners or renters insurance
- Any homeowners association costs you pay on your present property on a monthly basis
- Payments using a credit cards
- Payments on student loans
- Payments on auto loans
- Payments on personal loans
- Back taxes, alimony, or child support payments required by a court
The following costs should not be included in your DTI ratio calculation:
- Entertainment, food, and clothing costs
- Utility bills
- Transportation costs
- Savings account contributions
- 401(k) or IRA account contributions
- Health insurance expenses
Remember to only enter the bare minimum amount that you must make each month. if you have $10,000 in student loan debt but only have a $100 minimum required payment per month, only include $100 in your DTI ratio calculation.
Down Payment
As a general rule of thumb, the larger you can pay upfront as a down payment, the easier it is for you to get loan approvals, as lenders see a lower level of risk when you have a large down payment. A Federal Housing Administration (FHA) Mortgage has a minimum down payment of only 3.5%, but ideally, you will want your down payment to be above 20%. A larger down payment also means lower interest rates as lenders will have more confidence that you will be able to pay off monthly installments on time.
Credit Score
One of the most important criteria that lenders look into when approving any mortgage loan is your credit score. Having a good credit score of 750+ will significantly improve your chances to get loan approvals at your preferred loan terms, even with outstanding student loans. Credit scores are determined using information from your credit report, which includes information on your credit histories, such as loans, credit cards, and payment history.
Is it Better to Pay Off Your Student Loans Before Purchasing a Home?
Take a look at your DTI ratio first. Lenders are more concerned with how your debt compares to your overall income than with the quantity of debt you have. If you have a steady, consistent salary and keep track of your payments and pay timely installments of your, you may still purchase a home with school debt. On the other hand, unreliable income or payments may account for a significant portion of your entire monthly budget, and you may have difficulty obtaining a loan. If your DTI is greater than 50%, focus on paying down your debts before purchasing a property.
Before you consider homeownership, look into other aspects of your money. If you have a decent DTI ratio but no emergency fund, you may want to wait until you accumulate some savings. Learn more on emergency savings in our article here. Similarly, if your student loan payment is preventing you from contributing to your retirement, you should put off buying a property until you have paid off more of your debt.
Finally, pay attention to your interest rate. If your student loans have a high-interest rate, they will cost you more money over time. You may save money on interest by paying off more of your higher-interest loans before you buy a house. Examine your repayment plan and compare your monthly payments to the amount of interest that has accrued. You’re really getting deeper into debt if your payments are minimal, yet you’re not paying off enough to meet your monthly interest. In this circumstance, you should pay more than the minimum and prioritize paying off existing debts before taking on new debt in the form of a mortgage.
However, suppose you have a low DTI ratio, an emergency fund of at least 3 months of your current salary and some savings contributing to your retirement plans. In that case, you may consider buying a home before paying for your student debts altogether.
Valuable Tips for Making Your Mortgage Application Stronger
Pay Off Other Debt
Paying down minor debts is a good idea. This includes personal loans, credit cards, payday loans and vehicle loans. By eliminating those monthly recurring payments, your DTI will improve, signaling to mortgage lenders that you have more cash flow and enough for a home purchase.
While paying off a loan may not improve your credit score immediately, paying off revolving debt, such as a credit card, can significantly impact. Your credit card limit is listed as available credit on your credit report, so keep your credit utilization to a minimum. Learn more on how credit utilization can impact loans here.
Refinance All Student Loans
Refinancing is an option for both federal and private student loans, and it allows you to consolidate your obligations into a single personal loan. By lowering your interest rate, you can decrease your monthly payment. You can reduce your payment even more by extending your payback period. On the other hand, extending your term might raise your overall payback expenses, but make sure the loan is paid off quicker, and you will be debt-free earlier.
Refinancing your student loan and paying off the monthly payments on time will increase your credit score and, in turn, will help you get a mortgage at a lower rate. But Refinancing student loans has its pros and cons, so consider reading our in-depth article on student refinancing before moving forward.
Increase Your Income
Mortgage firms like to see a two-year solid job history. This work history does not have to be at the same company, but any prolonged breaks in employment might be considered a red sign.
Making more money is definitely a great way to increase your DTI ratio. You may achieve this by working part-time or upgrading your main hustle to a higher-paying one. It is easier than ever to start an online gig and earn money passively; check out our full list here.
Bottom Line: Can You Get a Mortgage with Student Loans?
You don’t have to be debt-free to purchase a house, but you can have difficulties securing a loan if you have too much debt. Calculate your DTI ratio by dividing your monthly debt payments by your total monthly income. If your debt-to-income ratio is more than 50%, pay down more of your debt before buying a property.
Also, before you invest in a property, be sure your financial status is steady. Before you look for a loan, be sure you’re on a good repayment plan, have enough money for a down payment (plus an emergency fund), and are saving for retirement.
It may be worth applying for a mortgage if you fulfill these requirements, even with outstanding student debts. To learn more about mortgages, consider keeping an eye on our daily blogs.
