How to Get a Mortgage with Student Debt
Many college graduates hoping to buy a home wonder how to get a mortgage while saddled with student loan debt. Is it even possible to take on more monthly bills when you're already haunted by college tuition? Turns out it is, in spite of how bad things look.
And yes, we know it looks quite bad. In fact, 41% of college-educated Americans with student loans report having postponed buying a home because of their debt, according to a recent survey by Student Loan Hero, a service that helps people pay off their student debt more efficiently. Making matters worse, student debt surged 56% from 2004 to 2014, to an average of $28,950 per borrower, reports the Institute for College Access & Success.
Nonetheless, owning a home is still well within reach for many—here's how to qualify for a mortgage while juggling college debt.
Understand debt-to-income ratio
One rule you'll need to understand is the debt-to-income ratio, or DTI, which compares how much money you owe (on student loans, credit cards, car loans, and—hopefully soon—a home loan) to your income.
Most mortgage lenders require a borrower’s DTI to be no more than 36%. The best way to think about this is in terms of your monthly expenses. For example, if you make $6,000 a month but spend $500 a month paying off student loans and credit cards, you divide $500 by $6,000 to get a DTI of 8.3%. This is well below 36%, but it will rise significantly if you add a mortgage to your monthly dues.
Want to get a ballpark figure of how much money you can borrow for a home while juggling debt? Simple: Just make sure your mortgage doesn't push your DTI into the danger zone above 36%. To figure that out, enter your income and debts into a home affordability calculator. For instance, in the above scenario, someone making $6,000 a month and paying $500 a month in debt would be able to afford a maximum monthly mortgage payment of $1,680—which, in many markets, is plenty to buy a house.
Refinance your student loans
While most college tuition borrowers get their original loan from the federal government, it's also possible to refinance with a private lender. So why would you want to? Because according to a recent survey by college lender marketplace Credible.com, one-third of these borrowers can snag lower interest rates with a private refi, which could free up cash for a home loan.
Another way to make room for a mortgage is to refinance and extend the life of your college loan. This results in smaller payments over a longer period of time—and more money you can put toward a mortgage. Of course, one downside is you'll end up paying more in interest over the life of your college loan; however, it means you can buy a home now, which may well be worth it. To learn more, Student Loan Hero picked six of the best private lenders for student loan refinancing.
Take advantage of Fannie Mae's new policies
Fannie Mae, the government-sponsored enterprise that buys and securitizes home loans, recently rolled out two new policies designed to make it easier for college grads with student loan debt to get a mortgage. Here's what's changed in your favor:
- Debts paid by other parties: One policy gives mortgage applicants the ability to exclude nonmortgage debt (like credit cards or student loans) paid by someone else (such as a parent or employer) from their DTI. As such, this option might enable you to stay below the 36% DTI threshold that most lenders set.
- Income-based repayments: In the past, lenders assessing your worthiness for a home loan were required to factor in 1% of your entire college loan balance as your monthly payment—which could be sizable and push you over that 36% DTI threshold. But now, Fannie Mae allows lenders to acknowledge that you could be paying much less than 1% if you participate in federal reduced-payment income-based programs. And that bodes much better for being approved for a home loan.
Look for local mortgage programs for college grads
Nearly half of states offer housing assistance to college grads carrying student loan debt. For instance, New York's new Graduate to Homeownership program provides assistance to first-time buyers/college grads in the form of low-interest-rate mortgages or up to $15,000 in down payment assistance. Granted, restrictions apply—for instance, you may be required to buy a home in certain areas—but it certainly pays to explore what your state offers in terms of assistance.
Clean up other aspects of your financial profile
Even if you're chipping away at a mountain of student loan debt, it does not need to sink your home-buying prospects because it's just one facet of what lenders look at to judge your eligibility for a home loan.
“Student loan debt is just one factor that affects your [mortgage application],” says Donna Bradford, assistant vice president at Navy Federal Credit Union's Metro Mortgage Processing & Closing department. So what else counts? Your income of course, and a good credit score, which means you pay your credit cards and other debts (including college loans) on time. A sizable down payment can also make a difference (more on that next).
Beef up your down payment
Even if you're trapped between a low income and high student loans, another way to pass muster is having enough cash to make a 20% down payment on your house. Lenders are much less likely to disqualify an application with 20% down, because it shows you have "skin in the game," as they say, which lowers the risk that you'll default on your loan.
Sadly, many young home buyers can't afford a 20% down payment, especially considering that 37% of millennial renters have not saved a cent for a down payment, according to a recent survey by Apartment List. But don't lose heart if you're low on cash; there are ways to save for a down payment fast.