Last Updated on May 19, 2022
Student loans can be a huge burden to bear. They can drain your bank account, and you may be hesitant to make big purchases like a new car or a house. However, if you are planning on buying a home, student loans might not be as much of an obstacle as you think.
Let’s start with the basics: how do student loans affect buying a home? When you apply for a mortgage, the lender will want to see proof of income and a credit score. If you have student loans, this information will be included in your credit report and could affect your ability to get approved for a mortgage loan.
However, student loans are an asset that can be used as part of your down payment on a house! This is because lenders consider student debt as being “good debt” since it’s likely that it will help them build their future by getting an education. In fact, some lenders even offer special programs that allow borrowers with student debt to use those loans as part of their down payment without increasing their interest rate or monthly payments!
How Do Student Loans Affect Buying A Home
Your student loan debt affects whether you can buy a house, in both direct and indirect ways. Here’s how:
- Student loan payments make saving for a down payment more difficult and mortgage payments harder to handle once you’re a homeowner.
- Student loan debt may increase your debt-to-income ratio, affecting your ability to qualify for a mortgage or the rate you are able to get.
- Missing a student loan payment can lower your credit score, but consistently paying on time can bolster it.
Having student loans, though, doesn’t mean you’ll never be able to get a mortgage. Here’s what you should know as you explore your options.
Student loan payments hinder savings
Sending hundreds of dollars a month to your lender or servicer may feel like the most immediate, and most frustrating, way student loans affect your ability to buy a house.
But saving up 20% of the home’s value for a down payment, traditionally the ideal amount, isn’t always necessary. Look into first-time home buyer programs in your state, which can provide money for the down payment, or low-down-payment mortgage options.
Federal agencies like the Federal Housing Administration and the U.S. Department of Veterans Affairs also offer mortgages that require smaller down payments — or none at all, in the case of VA loans.
Student loans add to your debt-to-income ratio
When deciding whether to approve you for a mortgage, lenders look at how much debt you already have compared with your pretax income. That’s called your debt-to-income ratio, known as DTI, and it’s calculated based on monthly debt payments.
There are different types of debt-to-income ratios, and not all mortgage lenders calculate them the same way. But in general, car loans, student loans, minimum credit card payments and child support all factor in. The more debt you have — or the lower your income — the higher your DTI will be.
A DTI of 36% or less is ideal, but government-backed mortgages, like FHA loans, may approve you with a DTI of up to 50%.
Consider focusing on paying off student loans, or credit cards if they have higher interest rates, and don’t add to your debt before buying a home. You could aim to get rid of one student loan payment before you apply for a mortgage; paying off the loan with the highest interest rate will save you the most money over time.
Refinancing student loans to a lower monthly payment may also reduce your debt-to-income ratio. But it adds a line of credit to your credit report and may extend your repayment timeline. Make sure you refinance six months to a year before you apply for a mortgage. That lets positive payment history offset the credit score dip that may occur from shopping for a refinance loan.
Student loan payments affect your credit score
A higher credit score means a better chance of getting approved for a mortgage and receiving a favorable interest rate. Payment history makes up 35% of your FICO score, one of the two main credit scoring models, and mortgage lenders want to see a history of on-time debt payments.
Consistently paying student loans on time will strengthen your score. On the flip side, a missed payment or letting your loans default will hurt it.
Credit mix is a smaller component of your score. But using a variety of credit types — such as student loans, car loans and credit cards — can help your score as long as you’re making payments on time.
will cosigning a student loan affect me buying a house
Cosigning a student loan can affect the cosigner’s ability to qualify for a new mortgage or refinance a current mortgage. In addition, as a cosigner, you could face higher interest rates or be denied a mortgage altogether. Although it might seem stressful at first, there are financial moves you can make that could help you get or refinance a mortgage.
Several steps can help a student loan cosigner to get or refinance a mortgage.
Apply for cosigner release
Qualifying for cosigner release on a student loan isn’t easy to do, but it is an option worth pursuing. Essentially, the primary borrower has to prove they are capable of making timely payments on their own for at least a year (in some cases, two, three or four years) before the cosigner can possibly qualify to be released. They also need good credit and have to be able to meet the lender’s income requirements. Your lender should have a form available to apply for a cosigner release.
Refinance the student loan without a cosigner
If the student qualifies for a better interest rate on a new loan, without a cosigner, they could refinance the cosigned student loan. Using this strategy, the new loan will pay off the original loan you cosigned. This option might help the student repay their loan faster, if they’re able to qualify for a lower interest rate. Generally, it takes a few years after graduation before the student can qualify for a better interest rate, if they manage their credit responsibly and have a good job.
If you do decide to refinance the current student loan, shop around and compare rates so your student gets the best terms possible. (Parents can also transfer a Federal Parent PLUS loan into the student’s name by refinancing it into a private student loan, but will lose the superior repayment benefits available on federal education loans. These include income-driven repayment options, potential for loan forgiveness, generous deferment options, a death or disability discharge, and more.
Reduce monthly student loan payments
When you’re applying for a new mortgage or refinancing a current one, the lender is going to be primarily concerned with the debt-to-income (DTI) ratio. The debt-to-income ratio is the percentage of your monthly income that is devoted to repaying debt, including the cosigned loan. If the debt-to-income ratio is too high, you’re less likely to qualify for a mortgage loan.
One option is to try reducing your monthly federal student loan payments by increasing the term of the loan or by taking advantage of an income-driven repayment plan. Increasing the loan’s term could mean more interest will be paid over the life of the loan. However, the monthly payments will be smaller, allowing you to qualify for a mortgage because less of your monthly income will be allocated toward student loan repayment
Pay off smaller loans or credit cards first
Another way to change your debt-to-income ratio is to reduce some of your other debt. Do you have any credit card debt with small balances that you can focus on paying off before you try to qualify for a mortgage? Or perhaps you can pay off a car loan, which reduces your monthly debt obligations. Knocking out some of the smaller debt could improve your credit report and prepare you to take on more financial responsibility in the eyes of a lender.
Increase income with a second job
Taking on a second job can reduce your debt-to-income ratio by increasing your income. You can also ask your employer for a raise. A lender will put most weight on the income from your primary job. However, income from a second job could help if you’ve demonstrated the ability to work two jobs simultaneously in the past and you don’t have a job gap of more than 30 days within the past 24 months.
Shop around for flexible lenders
Some lenders will be less risk-averse than others, so shop around. You might find a lender who is willing to help you with a mortgage despite the student loan debt. Consider credit unions and community banks, who tend to be more flexible than big box lenders. This is why it’s important to compare several lenders before you make a decision. Shopping around with various mortgage lenders will not hurt your credit score.