Here’s some advice about getting a mortgage when you’re still paying off your student loans.
The Differences Between Student Loans and Home Loans
Although student loans and home loans are both types of debt, they are quite different. Home loan interest rates are set by private lenders. They change frequently and are generally relatively low compared with other loans. Student loan rates are established by the government every spring and don't fluctuate much. They are generally much higher than home loan interest rates. Student loans are also more difficult to refinance than home loans.
To get a student loan, you'll need a credit score of 650 and up, or a cosigner, while the average conventional home loan lenders ask for a minimum credit score of 620, and you can get an FHA government-backed loan with a credit score of 580 or below.
Understanding Your Debt-to-Income Ratio
One of the main elements of getting a mortgage is your debt-to-income ratio. This means the percentage of your total monthly income which goes toward paying your debts each month. So for example, if you earn $1,000 per month, but you have to pay $330 towards your student loan, then your debt-to-income ratio is 33%.
When mortgage lenders consider your application, they’ll look at your front-end and back-end DTI. Front-end DTI, or the front-end ratio, means the percentage of your income which is spent on total housing costs. When calculating your front-end ratio, lending companies use something called PITI. This stands for Principal, Interest, Taxes, and Insurance, which are the 4 components of your total home loan payment.
Your back-end ratio, or back-end DTI, means your total debt-to-income ratio when taking into account all of your debts. So, your front-end ratio only refers to your total mortgage or rental costs, but your back-end ratio adds up all of your student loan debt, mortgage debt, credit card debt, auto loan payments, and any other debts you’re carrying. Ideally, lenders look for a DTI of 28/36. That means that your mortgage costs won’t be more than 28% of your income (a DTI of 28) and your total expenditure on debt won’t be more than 36% of your income (a DTI of 36).
How Can I Get A Mortgage If I Have Student Loans?
If you're carrying a large student loan debt, it can inflate your DTI and make it hard to qualify for a mortgage, but it's still possible to get a mortgage even with relatively high student loan debt. Here are some ways to qualify for a home loan with student loan debt.
Increase Your Down Payment
The higher your down payment is, the lower the amount you'll need to borrow and the lower your monthly interest payments will be. Getting a smaller mortgage means that your total DTI is lower and might make the difference between qualifying for a mortgage and being rejected. Sometimes, you can scrape together a larger down payment by borrowing from friends or cashing in on savings even while your student loan debt is high.
Improve Your DTI
There are 2 ways that you can reduce your DTI to make it easier to qualify for a mortgage. One is to lower the amount that you're paying for your student loan each month. If you have a student loan of $10,000 or more, you can probably consolidate it to get lower monthly payments. Student loan refinancing lets you use income-based repayments (IBR) which charge you a sliding percentage of your monthly income, for a maximum of 15%. Depending on your interest rates, you might want to aggressively pay off your auto loans or personal loans quickly to make a bigger dent in your DTI.
The other option is to increase your earnings so that the amount you’re paying to service your debt is a smaller fraction of your income. Getting an extra job on the side or running a small home business can boost your income and move you to a different level of DTI.
Check Your Credit Score
Along with your DTI and your down payment, your credit score is the most important element when applying for a mortgage. Most people only discover their credit score when they get rejected for a loan, which drags their credit score further down. By receiving a copy of your credit report from each of the three major credit bureaus, you can check your credit status and act to improve your credit score before applying for a home loan.
Build a Solid Employment History
Having a solid employment history when you apply for a home loan significantly improves your chances of being approved. Even if you’re carrying a high level of student loan debt, if you can show a good employment history you’ll be able to demonstrate that you are responsible and reliable. Lenders will know that you should be able to pay off all of your debt because you have a steady income.
Know Your Budget
You do have to be realistic when you apply for a mortgage and have student loan debt at the same time. Before applying, take a long and honest look at your financial situation. Use spending trackers and budget tools to work out what you can reasonably afford and look for places where you can cut your spending to save more money. It’s important to be sure that you can afford your mortgage payments without stretching yourself too thin.
Take Advantage of FHA Loans
First-time buyers can get help with finding a mortgage by applying for an FHA loan. FHA loans are much easier to qualify for than a conventional mortgage because they are backed by the government. This reassures the lender that if the borrower defaults on payments, they won't lose out on the entire loan amount. An FHA loan demands a lower down payment of at least 3% as long as your credit score is over 580, or 10% if it's below that. FHA loans are also available for borrowers with a DTI of up to 43%.
Student loans can be a bummer, but they don’t need to hold you back from home ownership. You took those loans for a better future, and that future can include your own home with some planning and knowledge.
For more information on rates and terms check out these reviews of the leading mortgage loan providers.