Hoping to buy a house while still carrying student loan debt might seem like a dead end – as in, why even try to get a mortgage? The typical amount of education debt outstanding in 2018 per person was between $20,000 and $25,000, according to the Federal Reserve Bank. On average, that’s a payment of $200-$299 month.
Remember, however, that a lot has changed in the years since college, including your income, your credit score, and your assets. Many people can buy a house if they have student loans.
Debt to Income Ratio
One of the first things a mortgage loan officer looks at is your debt to income ratio. That determines if you can afford monthly mortgage payments while still paying off other debts. To do this, they add up your monthly payments and divide them by your gross income (how much you earn before taxes and other deductions). To get a qualified mortgage, the Consumer Financial Protection Bureau recommends a debt to income ratio of less than 43 percent.
Let’s say you want a mortgage that equals a payment of $1600 a month. Add that to your monthly $260 student loan payment plus a $140 car loan payment, and your total monthly debt equals $2000. If your gross monthly income is $6000, then your debt-to-income ratio is 33 percent (2000/6000) and would meet the benchmark for a home loan.
Your credit score always plays a role in getting a mortgage. Your credit is one way that lenders decide whether or not they want to take you on as a borrower. Credit scores also can determine the interest rate you’re offered on your home loan – typically, good credit qualifies you for lower interest rates.
Reducing or getting rid of debt helps your credit score. It also improves your debt to income ratio. For example, some borrowers sell an expensive car and buy a less expensive one (or take public transportation), to reduce or get rid of monthly car payments.
Here are other ways to improve your credit before getting a mortgage:
- Pay bills early or on time
- Lower the revolving credit you’re carrying (i.e., pay down or pay off credit card balances)
- Don’t make any big purchases for a while
- Order your free annual credit report, authorized by federal law, to look for red flags for lenders. Work with the credit bureaus to get rid of any inaccuracies on your report.
If you’re just starting out to build credit, or starting over, one of the easiest and best ways to do that is with a secured credit card.
Assets and Down Payments
Buying a home usually requires making a down payment. Lenders want you to have skin in the game, so to speak, so that you’re motivated to make the payments on your loan.
If you’ve been working a few years, you may have built some assets that you could use toward a down payment – savings and/or a 401(k) retirement account. You’re allowed to borrow from your 401(k) to purchase a home; then you pay yourself back through regular payroll contributions. Before doing this, however, learn the pros and cons from your company benefits coordinator – there are some downsides.
Consider down payment assistance
In today’s mortgage market, there are a number of low and no down payment loans. For instance, if you’re an armed forces veteran, some VA home loans allow 100 percent financing. FHA loans for first time homebuyers have low, 3.5 percent down payments. Your income may qualify you for assistance, or the state/region where you’re buying a home. A mortgage loan officer can walk you through programs available to you.
Ask for help – gifts and co-borrowers
If you’re lucky enough to have a relative who’ll help you out, there’s no limit on the amount of gift money that can go into a down payment for a primary residence. Or, gifted funds could be used to pay down other debts and lower your debt to income ratio.
Getting a co-borrower or guarantor spreads the lending risk. If you have a guarantor (a co-signer), you and they will be equally responsible for the repayment of the loan. This may enable you to purchase a home when your current financial situation doesn’t meet lender guidelines.
The Most Important First Step
Every homebuyer’s situation is different. The best thing you can do is talk with a mortgage expert who will outline all your options and tailor a mortgage to your needs – before you start house hunting. A loan pre-approval arms you with the knowledge of exactly how much home you can afford to buy, and how.
If you’re in the market to buy a home, contact Capital Bank to speak to a knowledgeable, experienced loan originator.