Student loans can be a major obstacle when pursuing other financial goals, such as buying a home. Lenders prefer to approve borrowers with minimal debt. This is mainly because making a second loan payment increases the risk of defaulting on one or both of the loans.
Beyond the challenge of being approved, student loans can make savings on important home buying needs, such as down payments, closing costs, and travel expenses. However, there are ways to minimize the impact of student loans.
Does student loans affect the purchase of a home?
If you have a student loan, you can still buy a house. However, student loans are a type of debt, which affect your overall financial situation. It also affects your ability to buy a home or qualify for a mortgage.
There are several ways your student loans can affect your finances. All of these can contribute to your ability to buy a home.
Student loans will be added to your debt-to-income ratio
Lenders use the debt-to-income (DTI) ratio to determine mortgage eligibility. DTI includes all monthly debt payments, including car loans, personal loans, and credit card liabilities. Student loans increase your DTI. This is not ideal when applying for a mortgage.
For most mortgage lenders, the ideal DTI for a mortgage is less than 45%, including future mortgage payments. However, you can find lenders who accept higher DTIs. In addition to other monthly bills, high student loan payments can push DTIs beyond the required thresholds, making it difficult to qualify.
Student loan payments hurt your ability to build savings
To buy a home, you will need a prepaid down payment, usually several thousand dollars. If you have a student loan payment, it can be difficult to save on your down payment in addition to your monthly student loan bill.
For example, paying a student loan of $400 per month means you miss out on $4,800 in the potential savings of your home each year. Depending on the mortgage you choose and the home price in your area, that amount can be a down payment in just a few years.
If you’re struggling to save, you can explore low-down payment loan options, such as government-sponsored loans. These programs help you buy most or even zero homes instead of asking for a traditional 20% down payment. Be aware of the potential drawbacks of no down payment loans, such as higher interest rates.
Student loan payment history factor for credit score
Payment history is the most important factor in your credit score, accounting for 35% of your total score. Borrowers with on-time performance will increase their scores, while those who make late payments on student loans will decrease their scores. Consumers who have loans at defaults will result in a significant drop in their scores.
Mortgage lenders will give a big assessment of the weight of your credit score when determining your approval chance and interest rate. If you struggle to pay your student loan on time, your chances of qualifying for a mortgage can be hurt. Turning on Autopay reduces the chances of missing payments and negatively affecting your credit score.
The good news for borrowers is that the credit department generally gives more weight to recent mistakes over past mistakes. In other words, the mistakes you made at the beginning of your student loan repayment journey are less important over time.
Payment history is the most important factor, but other factors make up your credit score, such as the total amount you owe, the length of your credit history, and the credit mix. If strong in these areas, increase your overall score.
Do I need to pay back my student loan before I buy a house?
There are several reasons why you shouldn’t wait to buy a house if you’re ready. The biggest one is the rise in housing demand and prices over the past few years. It makes sense to lock yourself in your home as soon as possible before prices increase further. Please note that mortgage rates are still very high.
That said, in some scenarios, it makes sense to pay off your student loan before you buy a house. For example, if you are able to pay off your student loan within a year, we recommend completing your payment before undertaking the monthly expenses of your mortgage.
The same can be said when student loan payments make up a large part of your monthly budget and mortgage payments add an extra undue difficulty.
How to buy a house with student loan debt
Many people who buy homes and many others have student loan debt. Below are some ways to manage student loan debt while purchasing a home.
- Apply for a down payment grant: Local and national down payment assistance programs can provide down payment grants to first-time home buyers. These grants cover some or all of your down payment. Borrowers typically require a credit score of 600 or higher.
- Check for a 0% down payment loan. Previous and current service members are eligible for VA loans that do not require a down payment. People who buy homes in rural areas can also get a USDA loan with a 0% down payment.
- Reduce DTI: DTIs are based solely on monthly debt payments and not the remaining total, so you can reduce your DTI by quickly repaying small debts. You can also switch to longer student loan repayment plans, such as long-term student loan repayment plans and income-driven repayment plans to reduce monthly student loan invoices.
- Refinance Student Loan: Borrowers who took private student loans when interest rates were high should consider refinancing to a lower interest rate. Refinancing to a lower fee will make it easier to qualify for a mortgage, as it can save you interest and reduce your DTI.
Conclusion
Student loan debt may be a part of your life for over a decade, but this does not mean you have to wait for a home to buy. Important considerations to keep in mind are your credit score, income, other debts, and down payments that you can save before you start your search.
At the end of the day, your student loan payments are just another invoice that you have to pay each month. With some wise financial moves, your student loans don’t have to ruin your homeownership dreams.
