It costs more to get a college education than any other time in American history. Unfortunately, that’s forcing students to take out multiple loans to cover their expenses. Bigger loans — and more of them — means it takes the average graduate much longer to pay off their student debt.
And that, sadly, is causing many post-graduate students to postpone their dreams of buying their first home because of student loan obligations.
According to a recent report from the National Association of Realtors, half of U.S.-based non-homeowners — 51% — say student loan debt is causing them to put their home-buying plans on the back burner. In fact,
- 47% think having student loans makes it hard to save for a downpayment
- 45% believe existing debt will make it impossible to qualify for a mortgage
- 43% feel they have to put off home buying even though they’ve never even applied for a mortgage
Will student debt affect your likelihood of getting a mortgage?
Those concerns revealed in the NARs report have us wondering just how much student debt affects the ability to successfully get a home loan in today’s market.
According to the Education Data Initiative, the typical monthly student loan payment averages out to about $460. And it takes about 20 years to pay it off, during which the average borrower accrues $26,000 in interest alone.
That’s a huge chunk of change that can undoubtedly cause a lot of financial stress. But it also can complicate the home buying process. When a prospective homebuyer applies for a mortgage, the lender will require specific financial information — employment history, income, W-2s and bank balances. They also want to know about any debt you already owe, like car loans, credit card debt and outstanding education loans.
Student loans, in particular, may raise red flags. That’s because their balance size and long-term repayment schedules can cause more risk to your likelihood to repay a mortgage consistently and on time.
But while it’s not impossible to get a home loan while having student debt, there are a number of other factors to consider before taking the plunge into homeownership. Here are the 3 most important.
- Put away every cent you can for a down payment.
The old rule was that it takes a down payment of at least 20% of the home’s listing price to get approved to borrow the rest. While that’s no longer the case — there are many loans with zero or low down payment options — putting more money down upfront will help you get approved and get better terms. The more you need to borrow, the more you’ll be paying every month — that puts you more at risk of defaulting on the loan down the line. So, the closer you can get to 20% down, the less your lender will worry.
- Focus on how much you make at your job.
When it comes to deciding whether or not to approve your mortgage application, income plays a huge part. Your lender looks at your debt-to-income ratio to assess what you owe against what you earn. And although student loan debt is a big hurdle, many lenders look beyond the total balance owed if they see a good income in a field where income growth is expected. Some are even more willing to lend to first-time homebuyers with student loans because they most likely have a bachelor’s degree or higher, which in turn can result in a higher income over the life of a loan.
- Emphasize how long you’ve been working.
If your education includes graduate school, you probably owe more in student debt than someone with a 2- or 4-year degree. While that won’t necessarily sink your mortgage application, your lack of employment might. You see, while you were studying for those extra years, others were out there working. Lenders want proof of your ability to keep a job and retain an income. Some even prefer applicants who have remained in the same industry and with the same employer for at least two years. It shows consistency. With less than two years, you may have some challenges getting a loan — or the interest rate they offer you may be higher than usual.
Tips on improving your credit score, even with student loans.
Pay attention to monthly bills.
Try to pay more than the minimum amount due on a bill. Always pay monthly bills on time and in full. And never, ever, miss a payment. Do this and you’re on your way to building a consistent and solid credit history.
- Watch your credit utilization like a hawk.
The ratio between your non-student loan credit balances and your total available credit is called “credit utilization.” Optimally you want to keep your credit utilization below 30%. Let’s say you have available credit lines —car loans, credit cards, etc. — totaling $15,000 with balances totaling $6,000. Divide your credit balances by your credit lines: $6,000 / $15,000 = 40%. You’ll want to pay off some of your cards to get your credit to a more manageable level. Aim for 30% of your available credit.
- Don’t close down inactive accounts.
When preparing to apply for a mortgage, many first-time homebuyers think reducing their credit availability is a good idea. And while it’s true that you don’t want to open new accounts when you are applying, you also don’t want to shut down any that are old or no longer needed. Older bank accounts in good financial standing and inactive credit cards with a long credit history and no balances against them can actually help improve your credit score. Wait until after you close on your new home to get rid of those accounts.
- Maintain a healthy credit variety.
What does “variety” mean in this instance? It implies that you should try to have different types of credit in your financial portfolio in addition to your student loan. Before approving you for a mortgage, lenders look to evaluate your entire credit history. If you have just one type of debt and just one monthly payment, it’s hard to determine whether or not you have the maturity to handle the responsibilities of paying down a mortgage. With a few different types of credit, such as credit cards or a car loan, your prospective lender will see that you can handle all types of debt without missing payments or being late. That makes you a less risky candidate for a home loan!
Ready to graduate to homeownership?
If you’re a prospective first-time homebuyer with a good job, a little saved up for a down payment and a credit score is in good standing — even if you still have student loans — let’s talk. Reach out to Hung Le to discuss which mortgage option would be right for you.