Don't let student debt lead to regret
You've graduated from college, landed a good job and are eager to own a place of your own. Not so fast, prospective starter home buyer. Chances are, that significant student loan debt you've amassed could prevent you from getting a foot in the door of your first home.
That's because even if you can swing monthly payments for a mortgage and your student loans, it's going to be tricky to qualify for a home loan.
"When evaluating whether you qualify for a mortgage, lenders must determine your ability to repay the loan," says Lucy Randall, sales director at New York City-based online lender Better.com. "Lenders won't look so much at your total student loan debt, but they will focus on how much you pay each month toward those loans and how your monthly debt compares to your monthly income, as measured by your debt-to-income (DTI) ratio. The lower your DTI, the more financing options will be available to you."
Your DTI is the percentage of your pretax monthly income that goes toward repaying debt, including student loans, credit cards, personal loans and auto loans. To calculate your DTI, divide your total monthly obligations by your total income and multiply by 100 (for example, $2,000 in monthly debt รท $6,000 monthly income x 100 = a DTI of 33%). A DTI of 36% or less is ideal, although many lenders offer loans to creditworthy borrowers with a DTI as high as 47%.
A higher DTI can also hurt your credit score; the lower your credit score, the worse the interest rate offered and terms on the mortgage.
But having substantial student loan debt isn't necessarily a mortgage deal breaker. There are special loan programs you can apply for if you're eligible. The federal government and other government-sponsored organizations have created a variety of affordable lending options, including Fannie Mae's HomeReady loan, and Freddie Mac's Home Possible loan, each of which offers mortgages with down payments as low as 3% of the home's sale price. And an FHA loan can also be had for as little as 3.5% down payment.
If you still can't qualify for a mortgage, you can always delay your purchasing timeline and take steps now to improve your creditworthiness.
"Start by paying off all your outstanding credit card debt, which will increase your credit score. Get on an income-driven repayment plan," suggests Travis Hornsby, founder of St. Louis-headquartered Student Loan Planner.
Next, get serious with saving.
"Begin putting away every penny you can toward the down payment. Set aside extra for liquid reserves that you'll need for maintenance, repairs and unexpected home expenses," says Chris Griffith, owner and founder of Debt Does Deals in McKinney, Texas. "Also, delay any big-ticket expenditures, like the purchase of a new or used car, new furniture, technology and other unnecessary items."
Leslie Tayne, founder and head attorney at Tayne Law Group in Melville, New York, advises pursuing extra income opportunities.
"Seek out a raise or more hours at your current job or find other ways to bring in some extra cash. Because you're increasing your income, you'll be helping to lower your DTI. Additionally, having more cash flow can help make your monthly mortgage payment more affordable for the long-term," Tayne says.
Mat Ishbia, CEO at Pontiac, Michigan-based United Wholesale Mortgage, recommends consulting an expert, too.
"A mortgage broker can analyze your unique situation, explain what you qualify for when you have student loan debt, and prequalify you so that you'll be ready when it's time to purchase. This professional can show you how much house you can afford and determine a monthly payment you'd be comfortable with," Ishbia says.
When you've gotten your debt and savings under control and it's time to shop for a home, don't be afraid to start small.
"I had a lot of student loan debt, and I bought the cheapest two-bedroom, two-bath condo I could find near my office. I also rented out the second bedroom and applied those rent payments toward my student loans," says Rick Albert, a broker associate with Lamerica Real Estate in Los Angeles.
If, despite your best efforts, you're still not able to obtain or afford a mortgage, don't beat yourself up.
"Be patient, and rent if you have to. Spend time focusing on your goals of paying off your large student debt and saving money for a future home," says Tayne. "While renting can be frustrating, waiting until you feel more comfortable with mortgage payments can help secure a more successful financial future."