You’ve finished college, have a desirable job, and are ready to reach your next milestone: buying a house.
The only problem? You have student loans. The good news is that you’re not alone. The average student loan balance is $30,000, and more than two-thirds of college graduates have student loans. College graduates typically pay $400 a month in student loan payments, which many cite as the reason they are not homeowners.
However, student loans can be helpful if you have no credit history and make payments on time, establishing a good credit score.
Unless you are in a position to pay for your house upfront in cash, you’ll likely need to take out a mortgage.
Mortgage Eligibility
There are three things lenders look at when determining your eligibility for a mortgage:
- Your debt-to-income (DTI) ratio
- Your credit score
- Your down payment
Your DTI ratio is calculated by dividing your monthly gross income (before taxes or deductions) by your total monthly debt payments. Monthly debts include your student loan payments, credit card payments, car loan payments, and any other recurring monthly debits. The lower your ratio, the better.
For example, if your monthly gross income is $4,000, and your total monthly debt is $2,000, your debt-to-income ratio is 50%. Lenders prefer a debt-to-income ratio below 36%. However, if your debt-to-income ratio is close to that or higher, there are ways you can improve it.
- Pay off credit cards and other loans to lower your outstanding debt amount.
- If your student loans are federal, consider an income-based repayment plan, switching your plan at least a year before applying for a mortgage. (Avoid deferment or forbearance; although they will put a pause on your payments, they signal that you are not in a good financial place.)
- Request a raise at your job, if possible.
- Consider looking for a job that pays more, but try to be at a job for two years before looking for a mortgage.
- Consider a second job to help bring in extra funds.
- Review your budget to see where you can save more money.
- Consider whether it is possible and makes sense to consolidate or refinance your student loans to lower your monthly payment and interest rate.
Being able to prove a reliable and consistent income will go a long way with your lender, as well.
Your income doesn’t impact your credit score, but your debt does, and it impacts many of the factors that affect your credit score. One such factor is your credit utilization ratio, which compares your total revolving credit with the total amount of credit you have. Other factors that are taken into account are how consistently you pay your debts over time, how many hard inquiries have been made on your credit report, the total amount of debt you have, and the mix of credit you’re using.
To help your credit score:
- Make your monthly credit card and loan payments on time, in full, every month.
- Avoid anything that will require a hard inquiry on your credit score, such as applying for a new credit card.
- Pay down existing debt (this will help your credit utilization ratio and your debt-to-income ratio).
- Use credit wisely.
- Keep paid-off accounts open since the length of your credit history matters.
If you do not know your credit score, you can get a free copy of your credit report from each of the three nationwide credit bureaus once a year (you can stagger them to check your credit report every four months). If you see anything that is inaccurate, you can file a dispute to have it fixed.
The standard down payment is 20% of your mortgage. That number isn’t set in stone, but it’s generally the number that is used, and making a 20% down payment will make your mortgage application stronger. The median down payment in 2019 was 12% and 6% for first-time buyers.
Large down payments help to offset the risk that lenders make with mortgage loans. The more you pay upfront, the less remains on the loan, and, if you default and the loan has to be foreclosed, they lose less. Often, if your down payment is a higher percentage, the lender will offer a lower interest rate.
Down Payment Assistance
If you’re focused on paying down your student loans, you may need down payment assistance (DPA) when buying a house. DPA offers low-interest loans and grants to offset the amount potential homeowners need to save for a down payment – money that could go toward student loans instead. You’ll need to look into your state’s programs, though, as DPA can differ by location.
Some zero-down mortgage options include:
- USDA Loan Program: The U.S. Department of Agriculture has loans for low-income borrowers who choose to live in certain rural areas.
- VA Loan Program: The U.S. Department of Veterans Affairs allows a no down payment loan for military personnel, veterans, and their families.
- Native American Direct Loan: Eligible Native American veterans are provided with a Direct home loan to use federal trust land to buy, build, or renovate homes. This is a U.S. Department of Veterans Affairs program.
If you are primarily concerned with paying off your student loans first, you may even want to look into a mortgage that doesn’t require a down payment. This type of mortgage allows you to finance 100% of your home purchase, but you’ll be required to secure private mortgage insurance (PMI). The interest rate might also be higher than if you had secured a traditional mortgage.
If you don’t qualify for a mortgage without a down payment, you may still qualify for a mortgage with a low down payment. Some options include:
- FHA Loan Program: This loan is good for individuals with a lower credit score and a small amount of money available for a down payment, insured by the Federal Housing Administration.
- HomePath Ready Buyer Program: This provides 3% in closing cost assistance when buying a foreclosed Fannie Mae property and completing an educational course.
- 97% Loan-to-Value Purchase Program: Mortgages under this program only require a 3% down payment.
- Section 203(k) Loan Program: This allows you to roll the borrowed funds needed for home improvement projects into an FHA mortgage, with the minimum down payment at 3.5% with a credit score of 580 or higher.
- Energy-Efficient Mortgage Program: The cost of energy-efficient upgrades to a home can be combined into a primary loan for FHA or VA program borrowers.
You Can Buy a House Despite Student Loans
Saving for a down payment can be especially daunting when you also need to pay back student loans, but remember, more college graduates have student loans than do not. While it may sound cliche, slow and steady does win the race. If you work toward paying down your student loan, make consistent payments, and research mortgage programs that you might be eligible for, you can reach your goal of buying a house.
Homeownership is possible, and through responsible borrowing (only borrow as much as you need with the understanding that you are responsible for the amount borrowed), you can have the home of your dreams.
As you pay back your student loans, discovering the right loan repayment options for you at every stage of life, CollegeFinance.com is here to answer any questions you may have about the process, provide resources, and share new information. Student loans can affect buying a house, but they don’t have to prevent you from becoming a homeowner.
