Student loan debt in the U.S. is skyrocketing, growing at a rate six times faster than the country’s economy. With over 43 million student borrowers in debt, the average debt load per person is a staggering $39,351.
Carrying student loan debt can have several negative impacts on your life, one of which is its effect on your ability to secure a mortgage and buy a home. Here are some specific details you should be aware of regarding how your student loan debt can affect your borrowing ability.
Does Student Loan Debt Affect Your Ability to Buy a Home Directly?
Mortgage rates are currently at historic lows, making it an opportune time to consider purchasing a home, particularly for those who are currently renting. It is important to note that student loan debt can impact both your eligibility for a mortgage and the interest rate you receive.
When it comes to getting a mortgage, having student loan debt doesn’t impact your eligibility any differently than other types of debt.
Credit card debt and student loan debt have similar impacts on your financial situation. Both require repayment and are taken into consideration by lenders when reviewing mortgage applications. Lenders assess your ability to handle additional monthly payments based on your existing obligations.
If you qualify under the lender’s standards, they’ll decide on an interest rate.
Having student loan debt doesn’t automatically disqualify you from getting a mortgage, but it can.
Debt-to-Income Ratio
When it comes to student loan debt or any other financial obligation, the critical issue lies in how it impacts the debt-to-income ratio. This ratio is used to determine if you can manage your current payments and take on a new one for a home loan.
To calculate your debt-to-income ratio, add your current debt payments and anticipated mortgage, then divide by your gross monthly income. Gross monthly income is your earnings before deductions and taxes.
Having a debt-to-income ratio over 43% will likely result in mortgage loan denial, as most lenders have this threshold. It is recommended to aim for a ratio of 36% or lower. Additionally, experts suggest that monthly mortgage payments should not exceed 28% of your income.
When considering your financial situation, it is important to focus on your monthly debt obligations rather than the total amount of debt you have.
Flexibility in Payments
Changing your student loan repayment plan, such as opting for a graduated or extended repayment plan, can be a viable option to qualify for a mortgage with student loan debt. This is particularly beneficial if you have federal student loans. While you will still need to pay the same principal amount, opting for a different repayment plan can result in a lower monthly payment, which can help reduce your debt-to-income ratio. Keep in mind that this approach will extend the time it takes to pay off your loans.
FHA Changes
In the summer of 2021, an announcement was made regarding a change in the calculation of student loan debt as part of the debt-to-income ratio for FHA loans. This change aims to facilitate the process of obtaining an FHA loan for homebuyers with student loan debt.
Before the recent changes, FHA lenders were required to calculate a borrower’s monthly student loan payment by using 1% of the outstanding balance. However, under the new guidelines, the monthly payment amount used in calculating debt-to-income is now based on the borrower’s actual student loan payment, which is often lower. This change aims to provide a more accurate representation of a homebuyer’s financial situation and make homeownership more accessible.
Effects on Credit Scores
Having student loan debt can impact your ability to qualify for a mortgage due to your debt-to-income ratio. Additionally, your credit score, which is influenced by your existing debt, is taken into consideration by mortgage lenders.
An FHA loan could be a viable option for individuals with a low credit score. These loans are accessible even if your score is as low as 500, allowing you to afford a 10% down payment.
Overall, student loans don’t inherently affect your ability to get a mortgage, but in multiple indirect ways, they can and do.
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