Prospective first-time homebuyers today are struggling with a burden not typically experienced by their parents’ generation: overwhelming student debt.
According to a recent survey, 80 percent of people between the ages of 22 and 35 point to their student loans are the direct reason why they haven’t bought a house yet. Only a generation ago, this was never an issue.
There are currently 45 million people in the United States with student loan debt and recent graduates have an average balance of over $27,000.
On this page:
- Student Loan Impact on Home-Buying
- Will Federal Consolidation Help?
- Should You Refinance?
- How to Time It
Monthly student loan payments eat up a substantial amount of income which make banks wary of issuing mortgages to student loan borrowers. Yet, this hasn’t stopped millennials, who carry the most student loan burden, from purchasing homes.
Just how are they convincing banks to approve a mortgage if they also have quite high student loan balances?
Increasingly, first-time homebuyers with student loans are taking advantage of student loan consolidation and refinancing to improve their chances and reduce the associated risks of more debt.
How Your Student Loans Affect Your Home Buying Power
There are a number of factors which influence your eligibility for a mortgage. These include credit score, down payment, and debt-to-income ratio. Your debt-to-income ratio is an indicator of your debt burden on a monthly basis. Essentially, it shows what percentage of your monthly income does it take to pay down your debt.
The allowable debt-to-income ratio for first time home buyers varies from region to region. There are very likely different debt-to-income requirements for someone buying a home in rural Montana than someone looking to purchase in Manhattan. Under most circumstances, mortgage brokers will expect less than a 43 percent ratio. For example, a monthly income of $4,000, and debt repayments of less than $1,720.
If you’ve done a quick mental calculation, and believe you have a higher debt-to-income ratio, there are two options on the table which might help reduce your monthly payments. If paying down your debt isn’t an immediate option, consider one of the following.
Should You Do a Federal Loan Consolidation?
If you have federal loans, consider exploring what federal loan consolidation options are on the table for you. If you carry multiple federal student loans, you may be eligible for federal consolidation.
When you consolidate your federal student loans together with a Direct Consolidation Loan, you will only be responsible for paying one federal loan with an interest rate that is a weighted average of the other loans rounded up to the nearest eighth of a percent. Many borrowers also opt to extend their repayment terms when consolidating their loan with the government – lowering their monthly payments. With lower monthly payments, your debt-to-income ratio will also be reduced which would be a more positive signal to a mortgage lender, so it could help you.
You should be aware that by extending your repayment term, however, you will end up paying more over the life of the loan.
Should You Refinance Your Student Loans?
Student loan refinancing is similar to consolidation in the sense that it pays off multiple loans with one lump sum, except in this case you are consolidating with a private lender.
In most cases, the borrower also benefits from lower interest rates and – depending on the selected term length – lower monthly payments. Just like with a loan consolidation through the federal government, lower monthly payments and longer repayment terms could reduce your debt-to-income ratio. If this can reduce your monthly debt ratio, then it could be a good sign on a mortgage application.
Refinancing is available for both federal and private student loans, but refinancing is only offered by private lenders. As soon as you refinance federal student loans through a private lender you lose eligibility for all the protections and repayment plans that federal student loans come with.
If you think you will need income-driven repayment plans, student loan forgiveness, or deferment and forbearance protections in the future, you should avoid refinancing. You will end up relinquishing these benefits if you decide to refinance. You should also remember that extending your repayment term may cost more in the long run.
Timing Your Student Loan Refinance
If you’ve decided to apply student loan refinancing with a private lender and are also in the market for a mortgage, timing is of utmost importance. Applying for refinancing often requires a hard credit check which your credit score will be temporarily lowered.
As mentioned earlier, credit score is one of the deciding factors for mortgage applications and – although often not as important as the debt-to-income ratio – it still plays a vital role. If you want to refinance your student loans before applying for a mortgage, you may want to do it at least six months in advance so that the hard inquiry does not affect your eligibility or interest rate.
To sum it up, refinancing can help you apply for a mortgage, but it will only be worth it if you can it puts you in a position to more quickly reduce your debt balance. This can be especially handy if you have a high income which would allow you to reduce your debt-to-income ratio sooner rather than later – helping you become buyer-ready.
Author: Jeff Gitlen
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