If you’re thinking about buying a home but you have student loan debt, you might be wondering if you’ll be able to qualify for a mortgage. While many student loan borrowers are able to qualify for mortgages and buy their dream homes, others find that their loans are an impediment to their homeownership dreams.
It turns out that your student loans could help you in some ways when it comes to getting a mortgage, but they could also hinder you in a number of others. So, just how will student loans affect your mortgage application?
1. They’ll Impact Your Credit
When it comes to qualifying for a mortgage and determining your interest rate, having a good credit score is key. Student loans have an impact on your credit score in a number of ways and a few of these ways are actually beneficial to you. Since most students take out student loans in their late teens and early twenties, student loans are likely some of the oldest records on your credit report. Because of this, they boost your score since you get extra points for having longstanding credit accounts.
The fact that they’re loans can also help your score since they differentiate you from someone who has only ever had credit cards and you get a credit score boost based on having diverse forms of credit. If you’ve always made your payments on time, this will also help your credit since it shows that you’re reliable.
But student loans can also hurt your credit significantly and jeopardize your ability to get a mortgage if you have had late payments or if you defaulted on a student loan. This would mean that your credit score might be lower and it could be an impediment to qualifying for a mortgage.
2. You’ll Have A Higher Debt-To-Income Ratio
Lenders decide whether to give you a mortgage and how large of a mortgage you can afford by looking at a number of different factors. These include your credit, your down payment, your assets, and two different debt-to-income ratios. These ratios include a front-end ratio and a back-end ratio.
The front-end ratio is the ratio between your gross monthly income and your potential mortgage payment plus any taxes, and insurance you would owe on your home. Generally, most lenders want this ratio to be around 30%. The back-end ratio, in contrast, looks at all the debt that you have in relation to your income. This includes the total mortgage, insurance and tax costs that the front-end ratio includes but it adds in any other monthly payments obligations that you have in relation to your debt including credit card minimum payments and student loans payments. Most lenders will want to see that you have a back-end ratio that is less than 35-40% of your monthly income.
Because you have student loans, you’ll likely have a much higher back-end debt-to-income ratio than other borrowers. This ratio can decrease the likelihood that a bank will give you a mortgage or it will decrease the size of the mortgage that they’re willing to give you since they see your debt as a risk. They could still give you a mortgage but they might only do so at a higher interest rate to counter balance their added risk. Obviously, if you make a lot of money or if your student loans are relatively smaller, then this might not be a significant a stumbling block.
3. Your Down Payment
If you’re paying back student loans, it’s unlikely that you have a significant amount of money also squirreled away for a down payment on a home. Many people put any extra money they have towards paying down their loans more quickly, so many student loan borrowers have smaller down payments saved.
If you do have a smaller down payment, this will likely greatly decrease your chance of qualifying for a mortgage. Most experts suggest that you have at least 20% of the purchase price for a down payment. This will decrease the amount that you’ll need to borrow and can influence a lender’s decision to approve a loan. If you have less than a 20% down payment, you will likely have to pay for mortgage insurance on top of your mortgage payment.
4. Your Repayment Plan
If you currently have an aggressive repayment plan set up for your student loans, this might negatively affect your mortgage application. That’s because when mortgage lenders calculate your ability to take on new debts, they take into account your monthly payments on pre-existing debt in the calculation of your back-end ratio.
If you’re concerned that your student loan payments might negatively affect this ratio, you could think about switching to a less aggressive repayment plan before you apply for a mortgage. If you have federal loans, you might be able to easily do this by choosing an income-driven repayment plan. If you have private loans, however, you might be able to refinance your student loans in order to reduce your monthly payments. However, this is a big move, so don’t take it lightly. Student loan refinancing is taking on an entirely new loan to pay off your previous loans. With this new loan, you have the option to extend your repayment term (reducing your monthly payment by consequence), but it also comes with a new interest rate. If this rate doesn’t drop, then it removes some of the positive impact of student loan refinancing in general.
You can still continue to aggressively pay off your loans by overpaying your loans each month, but your official student loan payment won’t be as likely to affect your mortgage application.
You Can Boost Your Chances
If you’re worried about being denied a mortgage because of your student loans, you might consider focusing on aggressively paying down your loans before you purchase a house. You could also decide to save a bigger down payment which would reduce the amount you would have to borrow via a mortgage for your house. Another option is that you can get a co-signer to help you get approved for a mortgage.
Whatever you decide to do, know that owning your own home doesn’t have to be out of reach just because you have student loans.
Author: Jeff Gitlen
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