Back in September, the LA Times wrote a scathing article about the widespread effect that student loan debt is having on the housing market. One report they cited estimated that 414,000 home sales, or eight percent of the average number of annual home sales, will disappear because of this excess debt. The Federal Reserve Bank of New York backed this study up, claiming that people with student loan debt are less likely to hold a mortgage. Even the National Association of Realtors was fast to blame the sluggish housing market on student loan debt!
There’s no doubt that student loans can really throw a wrench in the works when you’re trying to get a mortgage, but having a student loan is definitely not the end to your mortgage hopes. If you’ve got good credit and a five percent down payment, the fight isn’t over yet. Let me walk you through some different ways you can still secure a mortgage with a student loan.
What is Debt to Income, Really?
Before we get too deep into this, I want to make sure you really, truly understand what the debt to income ratio is. This number isn’t arbitrary, it’s actually there for your benefit, believe it or not. For the purposes of borrowing money, your debt to income ratio basically caps how much you can borrow so you don’t get in over your head. When you’re a first time homebuyer, this is a great boon because you will probably underestimate what it really costs to own a home.
As the name implies, in this calculation your gross income is compared to your total debts. Easy, right? Where it gets tricky for a lot of people is what, exactly, your debts are. If you signed a note for a loan at a bank, make regular monthly payments on a note that’s got collateral, like a car or a boat, or have a credit card with a balance, these are definitely debts. If you are paying on a loan that you co-signed for someone else because they’ve defaulted, that’s your debt, too.
Even though you pay them every month and may even have a contract, cable, utilities and other subscriptions aren’t usually considered debt for mortgage purposes.
Examples of Debts Included in and Excluded from Debt to Income Calculations
|Included in Debt to Income Calculations||Not Included in D:I Calculations|
|Automobile Loans||Utility Bills|
|Personal Loans||Cable Contracts|
|Credit Cards||Rent-to-Own Furniture|
|Store Credit Accounts||Subscriptions (any kind)|
|Loans You’ve Co-Signed||Cell Phone Contracts|
|Recurring Medical Expenses|
When they do the calculation, your lender adds up all your current monthly debts and compares them to your current monthly gross income. So, if your car payment is $250, your student loan is $300 and you’ve got a credit card with a $150 payment, but you make $3300 each month, your current debt to income ratio is about 21 percent. Since most banks will loan to a 43 percent debt to income ratio, you’ve got plenty of room to buy a home. In fact, you can have a total of $1419 in monthly payments, making your total house payment (including principal, interest, taxes and insurance) $719. In many markets, this is a pretty decent house, so you’re good to go!
When Your D:I is Too High
The problem with student loans, besides the fact that they follow you until you die, is that there seems to be very little information out there on how to deal with them after you get them. That’s really odd to me, considering how much of our lives they consume. If you’ve got a student loan that’s causing mortgage problems, it’s usually because of one of these two scenarios:
Several different loan accounts. If you’re completely done with school, you can combine all those loans into one in most cases. Your Stafford, Perkins, PLUS and other federal loans will usually combine into one note with a single blended payment. It doesn’t cost you anything to find out if you can consolidate and it will reduce your payments dramatically. This is where you should consolidate — if you haven’t already, you really should drop what you’re doing and get started right now.
There is only one reason to keep your many scattered loans separate when you’re eligible for consolidation, and that’s if you’ve got a loan with forgiveness built into it. Some students were offered opportunities to work in high demand, low paying fields or regions with a limited number of that type of professional in exchange for a loan that shrinks over time. These are great, don’t touch them! You can still consolidate all your non-shrinking loans, though.
A student loan payment that’s crazy high. Believe it or not, you’ve got options — you don’t have to pay a student loan payment that keeps you in financial straits. In fact, if you’ve got a federal loan of any type, you’ll have several repayment options. Once you’ve consolidated, things should get much easier for you, not harder. Most people don’t pay attention to the optional offerings when they’re choosing their repayment plan, but they all should.
For example, if you borrowed the average $29,400 at 3.9 percent interest, your standard payment would be $296 — but if you apply for an Income Based Repayment (IBR), Graduated Repayment, Pay As You Earn or an Income-Contingent Repayment (ICR), it will drop considerably. There’s a calculator on the Federal Student Aid website to help you decide, but here are some basic numbers side by side.
Student Loan Repayments Based on loan amount of $29,400 at 3.9 percent interest. Borrower has an adjusted gross income of $39,600 and household size of 2.
|Program||Term||Initial Repayment Amount|
|Pay As You Earn||185 months||$133|
|Income Based Repayment||139 months||$200|
|Income-Contingent Repayment||153 months||$222|
As you can see, depending on which program you choose, you can halve your student loan payment in exchange for a slightly longer term. Since your bank is only looking at your monthly payment amount, this can make a huge difference to your home-buying power. Once you’ve got a repayment plan in place, that $719 monthly house payment can grow up to $882 if you want to go house hunting for something a little more upscale or in a better neighborhood.
When Repayment Plans and Consolidation Aren’t Enough
A lucky few of you got amazing education at pricey schools, were enrolled in a medical program or otherwise found a way to max out your student loans and are now wondering what to do about them. Grad school was probably great, but you still need somewhere to live — so now what? There are a few options for those of you who have insurmountable student loan debt, including:
A non-occupying co-borrower. If you’re borrowing using an FHA loan, you’re in luck! A family member or good friend can co-sign your loan to help improve your ratios. This is a tricky proposition, to be sure, but if your parents are mostly debt-free, your cousin started Google or you’ve got a good friend who has awesome credit, it might be a good choice. If you default, your co-borrower is on the hook for your loan, though, so be thankful if you can find someone who will do you this giant favor.
Co-borrowing with a spouse with no student loans. Many times, borrowers don’t want to involve their spouse or live-in significant other in the buying process. I’m no relationship counselor, but if you don’t trust them with your mortgage, you probably shouldn’t be cohabiting. There are reasons to keep them off the loan, to be sure, but if they’ve got a much lower debt to income ratio than you, adding your partner to the equation may compensate for your student debt problem.
Refinancing or paying down other debts. Your student loan payments won’t change much if you’ve already consolidated and applied for a non-standard repayment method, but you can still change your other debts’ payments dramatically. If you’ve got lots of equity in your car or other property securing a loan, consider paying the note off or refinancing to get a smaller payment. In most cases, you can still make the payment you were used to, but the new, lower payment requirement will reduce your debt to income ratio.
Bringing a larger down payment. Usually, I advise people to not bring more than a 10 percent down payment, since it hardly makes a difference in your loan rate or terms and it’s really good to have some cash on hand for household mishaps. But, if you’ve got a chunk saved and a high debt to income ratio, it may be a good idea to throw everything you’ve got at your loan. Debt to income is sometimes overcome a dollar at a time, so every buck counts! If you’ve got a family member willing to gift you funds to help reduce your principal and therefore your mortgage payment, so much the better!
The Bottom Line: Student Loan Debt Isn’t the End
Student loan debts may feel like a huge weight on your shoulders, but in most cases they won’t prevent you from buying a home if you’re willing to do some extra work to get them under control. Between consolidation, repayment options and the kindness of strangers and family, your student loans will just be another note in your lovely credit melody. For all the trouble they create, your student loans are an excellent way to build your credit and learning to manage them is good practice for your mortgage payments.